Tamara Burnell, head of sovereign and financials credit analysis at M&G Investments, shares her views on sovereign debt, regulation and political risk with Matt Hougan, global head of editorial at IndexUniverse.
IU.eu: There is a tremendous amount of noise about possible sovereign defaults right now. It’s hard to keep up. What are you monitoring right now to stay abreast of it all?
Burnell: The number one issue we’re focusing on is the interlinkage between sovereign debt and the financial system. That interlinkage has been particularly prominent over the last weeks in Europe. The release of the [European Banking Authority] stress test results didn’t tell us anything we didn’t already know, but it highlighted the degree to which banks are exposed to the debt of sovereigns.
An interesting proposed solution was to recapitalise those banks in the form of a conversion of debt to equity, which was a pretty punchy statement to make. That was followed up by the Financial Stability Board (FSB) suggesting that all uninsured creditors would be subject to a “bail-in”, if necessary.
Then, on July 21 we got an announcement from eurozone leaders, which was ostensibly about Greece but in practice was not about Greece at all. The politicians said that member countries would support their banks if necessary and even added powers for the European Financial Stability Facility and the European Stability Mechanism to use eurozone funds to recapitalise banks, not just in Greece, Ireland and Portugal, but also in other “non-programme” countries.
And so, within the space of a week we’ve come full circle, from a commitment to bail in bank bondholders, to another open-ended commitment to underwrite bank debts. I think this period of volatility in policymaking will likely continue through the rest of the summer. We’re due an announcement in September from the European Commission on the legislative proposal to force bail-ins, and it remains unclear whether they will align themselves with the FSB’s stance or with the eurozone leaders’ Greek bailout statement. Either way, we’re nowhere close to getting any sort of resolution to the crisis in Europe.
IU.eu: Why do you think there has been such a chaotic response on the part of regulators and financial authorities?
Burnell: The regulators have been reasonably consistent. We have seen some small differences between the recommendations from the FSB and Basel and those in the draft of CRD IV coming from the European Union, but I think the differences between regulators are relatively small, and mostly they are the inevitable consequence of each country having its own tax regime and its own legal regime. Given that each country is working within such constraints, I think regulators are doing a reasonable job.
The problem is that politicians are facing a wide array of other problems, including the liabilities that exist outside of the sovereign debt markets, such as their obligations to fund pensions, health care, and so on. Politicians have to balance those concerns alongside the more tangible market debt conditions. At some point, they will have to make a choice between meeting their internal obligations and meeting their obligations to investors.
IU.eu: How has that realisation affected your investment strategy?
Burnell: In reality it hasn’t changed our investment strategy at all. Our philosophy has always been to invest in assets that we can understand and can get as close to as possible. We like to invest where we can gain a competitive advantage by understanding the legal contract, and where we think we know how we would do in a workout scenario. We like to be invested in secured debt, wherever possible.
The way we invest is not in a big picture way, by asset class; it’s very much to spot individual opportunities that are likely to be resilient to a range of economic and political scenarios. We don’t make a recommendation to go overweight on Ireland, for instance, but we might pick an individual bond offered by a mortgage bank subsidiary of one of the Irish banks. We’re looking for opportunities within the secured bond markets, but we don’t take a blanket approach to buy all secured bonds.
Well-secured old vintage asset-backed securities (ABS), even in some countries whose debt markets are under pressure, like Spain, can look very attractive, but that doesn’t mean that we would take a big picture macro decision to go into Spanish debt generally. It’s all about understanding the individual bond and contract.