The active buying and selling of securities in any market (i.e. trading) will allow the pricing level of a given risk profile and a given maturity profile to be established. Where this occurs there is said to be liquidity in the market. In general, a liquid secondary market for bonds lowers the funding costs for issuers by reducing the liquidity premium demanded by purchasers of those securities in the primary market. A liquid market is also believed to improve the price efficiency, and therefore the information content of observed prices, of a market.
The secondary market trading level and pattern of buying and selling will therefore be a guide to pricing a new issue, and will also be a guide to where demand exists in the maturity spectrum.
The sterling PFI bond market is relatively illiquid, and it sees relatively modest issue sizes. Over the past three years, the typical PFI bond issue has raised less than £150 million and in the last 4 years only 6 of a total of 16 PFI bond issues have been above £100 million. The smallest, Caledonian Environmental Services, raised £63 million, and was essentially a private placement, being bought by a sole investor. Most PFI bond issues are simply not large enough to be liquid. The exception is the £406.85 million issue for Integrated Accommodations Services plc (guaranteed by FSA, led by Deutsche Bank), which closed in June 2000. This deal has seen fairly active trading.
There will tend to be a trade-off between size and price. Small, illiquid transactions are at risk of attracting an investor price premium to compensate for the 'take and hold' nature of the deal. On the other hand, very large transactions can suffer from the effect of the 'marginal investor'. In other words, there may be a requirement to pay a higher spread in order to sell the last £50 to £100 million of bonds, whereas a slightly smaller transaction could have been sold at a cheaper spread. This is simply illustrated by the build up of the 'book' for a transaction of size which would normally illustrate the total level of demand from investors at differing levels of issue spread for differing order sizes. There is therefore the outline of a 'pricing dumbbell', with spreads being wider for both very small and very large transactions, whilst those in between, of sufficient but not excessive size, achieve more favourable pricing.
At £127.8 million, the Exchequer Partnership bond issue was a good size for the market. It was not so small that investors could seek a large illiquidity premium, nor was it so large that it would have experienced the difficulty of attracting the marginal investor.