Emerging-Market Borrowers Raising Cash in Pounds at a Record Rate
The U.S. dollar is still king, and the euro its main challenger, but the British pound is fast becoming a funding currency of choice for many emerging-market borrowers.
Issuers from developing nations have raised 1.93 billion pounds ($2.48 billion) this year, according to data compiled by Bloomberg. That’s the highest-ever bond sales in the currency during the first 50 days of any year, and already equal to 58% of the record full-year issuance in 2007.
The election of a majority government and Britain’s exit from the European Union on Jan. 31 ended four years of Brexit-related uncertainty. Political stability is keeping the pound steady, while rate-cut bets and falling hedging costs are luring borrowers. For investors, the ability to earn between 60 and 235 basis points over U.K. borrowing costs, depending on the tenor, is the main attraction.
This is only the fifth time in the past 22 years when there was any pound borrowing at all by emerging markets this time of the year. Bond sales in the past seven weeks exceed even the full-year issuance on 18 of those years. That signals the pound is becoming more of a trendy choice: total issuance since 2016 has reached £7.4 billion.
That’s still a tiny share of all emerging-market borrowing. The U.S. dollar dominates the scene, with $136 billion since the start of 2020. Issuers have also raised 17 billion euros ($18.3 billion) of debt. But the following factors suggest the pound may gain a bigger share of developing-nation debt markets:
Freedom From Dollar
Borrowers have been looking to diversify their sources of funds to protect cash flows from sudden currency movements, especially against the dollar, and monetary-policy uncertainty. Dependence on dollar markets can bring quick and immense pressure on borrowers, as a seven-year streak of depreciation in the Turkish lira shows.
The pound, wedged between the U.S. and Europe on the scale of borrowing costs, offers a balanced exposure to cheap money and relative exchange-rate stability.
“GBP issuance is part of a global trend of diversifying away from dollars and euros,” said Richard Segal, a senior analyst at Manulife Investment Management in London. “From the issuer’s perspective yields have declined, like in other G7 countries, and it’s an opportunity to diversify the investor base. Plus the general level of uncertainty has declined after the last elections.”
Currency fluctuations are not the only thing worrying issuers. U.S. policy on foreign affairs and trade has exposed them to the risk of sanctions and other punitive actions. For instance, companies in China not only face the burden of high tariffs on exports to the U.S., but also have to contend with concerns about market access if relations worsen.
“U.S. international economic policy has been instrumental in encouraging borrowers to think opportunistically,” said Segal. “Emerging issuers cannot ignore the future risk of sanctions on governments or trade wars even if they aren’t worried about that imminently.”
Since the U.K. voted to leave the EU in June 2016, borrowers have found the cost of hedging their pound liabilities become more expensive relative to the dollar. But those costs, measured by cross-currency swaps, are declining now.
A bond issuer seeking a swap hedge would pay a dollar interest rate and receive corresponding pound rates. In the three-month market, that difference kept rising since the Brexit vote and was the most expensive at the end of 2018. Since then, it has fallen.
While that cost may fluctuate in the future, a desire to reduce dollar liabilities and seek refuge from U.S. foreign-policy surprises may make emerging-market borrowers see the pound as a white knight. A rate cut by the Bank of England or an economic boost from Prime Minister Boris Johnson’s fiscal largesse would add to the glamor.
The pound strengthened 0.4% against the dollar on Friday.
©2020 Bloomberg L.P.