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Euro Woe Spurs Revival in Sterling-Denominated Corporate Bonds

Corporate issuance in the U.K. currency is up 46 percent this year as the pound is seen as a relative oasis in the euro desert.

This week’s £700 million ($1.1 billion), 15-year sterling-denominated bond issued by Brazilian oil company Petrobras is the largest emerging markets corporate bond ever issued in sterling. But it’s only the latest example of a revival in sterling issuance that is set to continue into 2012 amid the prolonged euro crisis.

Once neglected even by U.K. corporations, as the euro offered bigger pools of investors, new issues in sterling are up 46 percent this year according to Dealogic, as an increasing number of companies from outside the U.K. choose what they see as a safer market that offers strong investor demand. Meanwhile, euro issuance by corporations has slipped by 17 percent.

Indeed several euro zone corporations have been among the sterling issuers, notably French utilities Electricite de France’s 30-year, €1.25 billion ($1.69 billion) bond issued in November, and GDF Suez, which raised €400 million in the same month. Companies from further afield, such as U.S. biotechnology firm Amgen Inc., have also joined in.

“Sterling offers a relative oasis. It’s a stable, risk-free rate,” says Nick Gartside, international chief investment officer for global fixed income at J.P. Morgan Asset Management in London.

The diversity of issuers in sterling is unusual and at least partly reflects a lack of confidence in the euro zone, as European politicians struggle to reach agreement on concerted action to deal with their sovereign debt problems, says Frazer Ross, managing director within debt syndicate at Deutsche Bank, a lead manager on the Petrobras deal. “The sterling revival comes as a surprise given most big non-U.K. corporates generally require dollars and euros, not necessarily pounds. They typically only issue in pounds if there is a significant arbitrage to their home currency.” In the case of Petrobras, there was a need to diversify its issuance while it funds a big capital investment program, he says.

For issuers, the U.K. market offers plenty of available cash. As Nick Hayes, senior portfolio manager in fixed income at Axa Investment Management says, “It’s impossible to quantify, but there is a lot of cash in the system, thanks not least to quantitative easing. “ QE, as it’s usually known, is being revived by the Bank of England, which is planning to make £75 billion of asset purchases over the next few months. Although it will only be buying gilts (U.K. Treasury bonds), there will be a domino effect on the corporate bond market as financial institutions sell gilts to the bank and divert money into other bonds. When the bank last began a round of QE, in 2009, sterling corporate bond issuance doubled to $80 billion.

For investors seeking a haven from the euro zone, there are attractive spreads at a time when benchmark 10-year gilt yields are not much above 2 percent. Recent issues in the U.K. retail sector by Marks & Spencer and William Morrison offered 390 basis points and 225 bps more than gilts, respectively, and up to 30 bps more than prices of that in the secondary market.

True, sterling remains a relatively small market with only $45 billion of issues compared to $185 billion of euro issuance up through December 6 of this year, according to Dealogic, but the gap is closing compared to previous years. What’s more, U.K. companies are now more likely to issue in pounds rather than euros—a reversal of the market from only three years ago. So far in 2011, there has been $27 billion of U.K. corporate issuance in sterling, compared with $10.4 billion in euros. In 2008, U.K. corporations issued $14.5 billion of sterling bonds, compared with $28 billion in euros.

There will be limits, however, to sterling’s popularity given economic conditions. As Ketish Pothalingam, senior vice president and portfolio manager at Pimco in London, says, “I think there is room for much more issuance next year, but we’re unlikely to see a dramatic pick-up because not all investment-grade corporates have a pressing need for funds.”

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