U.K. Debt Market at Risk of Drought as Companies Shift to Euros

Updated on
Prime Minister David Cameron
David Cameron, U.K. prime minister and leader of the Conservative Party. Photographer: Chris Ratcliffe/Bloomberg

The U.K. corporate bond market is being eclipsed by the euro region, threatening its future as a major market for issuers and investors.

Companies are abandoning sterling bonds as European Central Bank stimulus suppresses borrowing costs in the shared currency, while investors seek securities that are easier to buy and sell. The shift may make it increasingly difficult for companies to raise funds in pounds and for investors such as pension funds that need to hold sterling assets.

Sales of notes denominated in pounds dropped to the lowest since 2010 this year, while U.K. companies including a unit of Heathrow Airport Holdings Ltd. issued a record amount in euros, according to data compiled by Bloomberg going back to 2009. Retail investors pulled $433 million out of investment-grade sterling credit funds and added $20.5 billion to euro funds, according to Bank of America Corp.

“In the long term, there’s a question mark over the sustainability of sterling credit as an actively-traded, liquid and international market,” said Zoso Davies, a credit strategist at Barclays Plc in London.

Heathrow Funding Ltd. and National Grid Plc were among U.K. borrowers that sold 20 billion euros ($21.9 billion) of notes in the single currency this year.

Royal Mail Plc, the U.K. postal service that gets 83 percent of revenue from its home country according to Bloomberg data, chose to sell its first bonds in euros last year. Merlin Entertainments, the Dorset, England-based manager of attractions such as Madame Tussauds and Alton Towers, also chose the single currency for its debut bond sale in March.

Relative Value

Companies are being drawn to the euro bond market because the average cost of borrowing is close to the lowest versus the U.K. in five years. Investment-grade notes in the single currency yield 1.09 percent, compared with 3.11 percent for those in pounds, according to Bank of America Merrill Lynch index data.

Issuers worldwide have sold 28.7 billion pounds ($44 billion) of bonds in the British currency this year, down 12 percent from the same period of 2014, according to data compiled by Bloomberg.

The sterling market hasn’t dried up completely. Companies sold 2.9 billion pounds of bonds last week, the busiest this year, after a surprise majority for Prime Minister David Cameron’s Conservatives in the May 7 general election ended months of political uncertainty. Whitbread Plc sold its first notes since 1997 and Center Parcs, the U.K. operator of holiday sites owned by Blackstone Group LP, issued 490 million pounds of bonds to refinance debt.

Pension Funds

“The risk is that the market continues to shrink to the point that companies only borrow in response to inquiries from U.K. investors,” said Luke Hickmore, the Edinburgh-based senior investment manager at Aberdeen Asset Management Plc, which oversees about $504 billion.

Long-dated bonds, which companies historically issued in the sterling market to match demand from U.K. pension funds, are also moving to Europe. A change to the industry reduced demand for the assets used to back payments to retirees at the same time as borrowers sought to take advantage of lower costs in euros.

The average maturity of investment-grade sterling corporate bonds has fallen to 12.6 years from 13.2 years four months ago, while that for euro notes has lengthened to 5.7 years from 5.5 years, according to Bank of America Merrill Lynch index data.

“The lack of issuance is damaging,” said Daniel McKernan, the Edinburgh-based head of sterling investment-grade credit at Standard Life Investments, which oversees about 246 billion pounds. “The danger is that these trends continue and liquidity gets even worse.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE