FOR PROFESSIONAL CLIENTS / QUALIFIED INVESTORS ONLY

In this edition we explore:
Gilt issuance via syndication

  1. What is a syndication?
  2. Why are syndications important?
  3. May 2018 Syndication
  4. Implications for LDI investors

 


PORTFOLIO DESIGN

LDI newsletter – July 2018

BlackRock |23-Jul-2018

1. What is a syndication?

The UK Debt Management Office (“DMO”) issues new gilts in three ways: auctions, tenders and syndications. Auctions constitute the primary means of gilts issuance, with only Gilt-Edged Market Makers (“GEMMs”) and members of the DMO’s approved group scheme able to submit bids. Gilt tenders help to supplement supply in between auctions, and will typically be for existing gilts and lower size than auctions.

Syndications are larger supply events which only occur 4-5 times a year and they give end investors the opportunity to directly participate in primary issuance. The DMO will typically announce details two weeks ahead of an intended syndication including gilt maturity, coupon and the panel of investment banks appointed to manage the process.

Order of events of the day of a syndication

Source: BlackRock. For illustrative purposes only.

The DMO’s financing remit for 2018-19 details plans for two long nominal and two index-linked gilt syndications. Since the beginning of this fiscal year, the DMO syndicated a 2071 conventional bond in May, and announced plans for a syndication of a 20-25y index-linked gilt in July.

Expected DMO Issuance April-September 2018

Expected DMO Issuance April-September 2018

Source: BlackRock, DMO, July 2018. For illustrative purposes only. The calendar of gilt issuance shown above displays confirmed notional amounts of auctions and syndications in the period from April – June 2018. Issuance in the July – September 2018 period are BlackRock estimates and realised notional amounts of issuance may differ from forecasts. The DMO has confirmed that the syndication of the 2041 new index-linked gilt will take place in the week starting July 9th, 2018. There is no guarantee that any forecasts made will come to pass.

To put this into context, the table below summarises the total cash raised by the DMO through issuance over the last 5 years, and the proportion that has been via syndication.

Table 1 – Actual cash raised by the DMO through issuance over the last 5 calendar years to 2018

Table 1 – Actual cash raised by the DMO through issuance over the last 5 calendar years to 2018

Source: BlackRock, DMO, July 2018. * 2018 (projected) figure uses expected issuance data from the chart above to September 2018, and assumes the same constant 2018 rate of issuance applies in Q4 2018. There is no guarantee that any forecasts made will come to pass.

From Table 1 above, it appears the amount of issuance over 2018 could be lower than recent years, by c. 25%, which could have knock on impacts to gilt yields if supply is squeezed vs. demand. We can attempt to forecast whether this impact might persist over the next 5 years by estimating what the DMO what need to issue over the next 5 years, with some broad assumptions:

Assumption 1: All outstanding debt maturing in each year is refinanced immediately and in full in that year; and

Assumption 2: The UK government’s budget deficit remains constant at its 2017 level, £39bn (source: ONS).

Table 2 – Estimated Cash raised by the DMO through issuance over the next 5 calendar years from 2018

Table 2 – Estimated Cash raised by the DMO through issuance over the next 5 calendar years from 2018

Source: BlackRock, DMO, ONS, July 2018. Figures assume that all outstanding debt maturing in each year is refinanced immediately and in full in that year, and that the government must issue an additional £39bn each to cover its budget deficit. There is no guarantee that any forecasts made will come to pass.

Table 2 demonstrates that, in the absence of a material improvement in the UK government’s budget, the level of issuance over the next 5 years could be expected to continue in line with the level seen over the previous 5 years, or indeed be slightly higher on average. This suggests that a supply squeeze is less likely in the near term.

2. Why are syndications important?

Syndications are large primary supply events providing significant market liquidity, both in the bond being syndicated and in the wider market with many participants active in the run up to and on the day of the syndication. Investors can take advantage of this increased liquidity in two ways:

    1. Transacting larger sizes with lower, or even no, transaction costs vs. a typical market day due to the increased market activity; and
    2. Benefiting from attractive pricing on the bond being syndicated, which is often priced at a discount to perceived fair value due to large supply and the DMO and panel banks wishing to quickly establish a market in the newly issued security.

3. May 2018 Syndication

On Tuesday 15th May 2018, the DMO issued £6 billion of a new nominal gilt via syndication, maturing in 2071 with a coupon of 1.625%. This extended the maturity of the gilt market, which previously went out to 2068. The syndication attracted 148 orders totalling £37.8 billion, amounting to the largest order book in nominal terms for a syndication to date. As a result of strong demand, the DMO decided to increase the issue by £1 billion.

The 2071 gilt was priced at £97.615 per £100 nominal, equivalent to a gross redemption yield of 1.693% which represented a 0.5 basis point (0.005%) spread below the yield on the 2068 conventional gilt. This price was lower than BlackRock’s estimates of fair value, which implied a spread of 2-3 basis points below the yield of the 2068 conventional bond.

As the 2071 bond had a longer duration than the comparable 2068 and 2065, the syndication presented an opportunity for LDI investors to switch out of 2068 and 2065 gilts into the new conventional 2071 while retaining equivalent hedging and releasing cash. The longer duration also meant the accuracy of hedging of very long dated liabilities could be improved by switching into the 2017 gilt.

4. Implications for LDI investors

Syndications can offer a range of opportunities for LDI investors looking to extend their hedge in a low-cost way, improve cost efficiency by releasing cash and retaining their hedge or improving the accuracy of their hedge. LDI investors planning a hedge extension should be aware of any upcoming syndications that may offer liquidity points, and investors interested in taking advantage of these opportunities that may add value should give discretion to their LDI manager to do so as they arise.

 


 

The opinions expressed are as of date and are subject to change at any time due to changes in market or economic conditions. The above descriptions are meant to be illustrative. There is no guarantee that any forecasts made will come to pass. Unless otherwise stated all data is as at July 2018; Source: BlackRock.

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