IFR Editor-at-large Keith Mullin
IN ANOTHER EVENTFUL week in the financial markets – more bank earnings (Deutsche Bank, UBS, BNPP, RBS), ECB rate cut, bit of market volatility etc – market watchers could probably be forgiven for perhaps failing to pick up on what I consider to be a pretty significant announcement.
When most of Europe was off celebrating International Workers’ Day on May 1 (the day ironically enough when no-one actually works), Assistant Secretary for Financial Markets at the US Treasury Matthew Rutherford announced in the Quarterly Refunding Statement that the about-to-be-launched Treasury FRNs would be indexed to the High Rate of 13-week Treasury bill auctions. He said the Treasury plans to issue a final rule on FRNs in the coming months and confirmed that the first auction is scheduled to take place in the fourth quarter of this year or in Q1 2014.
The final confirmation comes after more than two years of discussion. As far back as February 2011, the Treasury convened meetings with a wide range of market participants and observers to look at debt alternatives. As well as FRNs, they looked at things like ultra-long bonds, callable and put-able structures, TIP strips and GDP-linked bonds. Last March, it sought market feedback on likely FRN demand, structure, liquidity, indexing and operational issues; its formal request for comment letters came in the December 5 Advance Notice of Proposed Rulemaking.
While from the borrower’s perspective, serial issuance of FRNs would tend to infer expectation of a sustained low-rate environment – the Treasury pointed to its clearly articulated objective of financing the government at the lowest cost over time – the US$10bn to US$15bn of expected monthly issuance, initially targeting the two-year maturity, will likely find favour with banks, investors and traders keen to hedge interest-rate risk and at the same time earn the positive Treasury FRN- T-bill spread. For banks, they’re likely to be a useful tool to meet and manage minimum liquidity ratio requirements.
ODDLY ENOUGH, THE Treasury FRN plans come just as the market is getting ready for a period in which bond yields are expected to start to tick up as the Fed dampens its asset purchases as monetary stimulus starts to fade. So at the same time as this is a risk to the Treasury, FRNs could in equal and opposite fashion be a boon for the Fed, which could become a huge buyer to hedge its massive balance sheet replete with Treasuries and mortgages.
A key element of the decision to issue FRNs lies in the Treasury’s decision to use actual rates as the index basis. This is a huge step forward in the slow and potentially painful transition away from the use of theoretical composite interbank rates. During its data-gathering phase, Treasury officials had noted that there was no consensus among market participants on the ideal index for its FRNs but pointed to a body of support for a liquid, traded rate with transparent pricing.
Using T-bills will offer borrowers and investors a much cleaner rate that’s home-grown
Using T-bills will offer borrowers and investors a much cleaner rate that’s home-grown (important for the American psyche) as opposed to some notional rate that in the case of Libor is not just far from representing anything tangible or real: it’s compiled in London. Added to the JP Morgan Whale saga, London has been to some extent discredited in the eyes of many. The US regulatory zeal to force its foreign banks to up the capital of their US subsidiaries is evidence of clear mistrust of international regulation. De-globalisation is the new globalisation.
The Treasury had looked at two indices for its floaters: the 13-week Treasury bill auction High Rate (stop-out rate) converted into a simple ACT/360 interest rate; and a Treasury general collateral overnight repo agreement rate (using the highly liquid US$650bn per day overnight collateralised loan market), as part of its mission to reduce borrowing costs, better manage its maturity profile, diversify its investor base and create a tool that offers debt managers added flexibility.
Officials conferred with primary dealers and with the Street in general via the Treasury Borrowing Advisory Committee, the SIFMA-sponsored federal advisory committee of Wall Street dealers that’s chaired by Matt Zames of JP Morgan and vice-chaired by Ashok Varadhan of Goldman Sachs.
ONE OF THE big questions surrounds the follow-on impact on corporate debt capital markets. Assuming the Treasury becomes a big seller of floating-rate debt and buyside flows transition slightly away from conventional Treasury debt (which will in turn alter the market’s yield dynamics), there’s every likelihood that corporations will follow suit and start to tap the FRN market with more frequency.
You’d imagine that investors would be attracted to corporate floaters, particularly for investment-grade names, and particularly also if the Treasury starts to print down the maturity spectrum. Corporates have increasingly looked to floating-rate debt as the interest-rate conversation shifts, both in the US and Europe. Autoroutes Paris-Rhin-Rhone, Vinci, Carrefour Banque, Volkswagen and General Electric all sold FRNs in April, partially driven by reverse-enquiry interest.
There is a risk that a risk-free issuer offering paper in size could have a crowding-out effect and obliterate demand, certainly in the early stages of the new market. But as the market settles, I expect to see corporate issuance volumes tick up. Boom? Probably too early to predict, but it’s certainly a theme that’s going to catch on.
