2.20 In June 1998, when the agreement to provide a Government guarantee for the bonds was given, conditions in the sterling capital markets were relatively stable and it was expected that the bonds could be issued at a relatively small interest premium to Gilts. Before any GGBs could be issued, their detailed terms had to be agreed and the restructured deal itself, including the use of GGBs, needed to be reviewed by the European Commission for compatibility with state aid provisions. In late 1998 and early 1999, however, financial instability caused by the Russian debt crisis and the near failure of a major hedge fund caused interest rate margins on corporate bonds to increase dramatically against the rates payable on "risk free" Gilts. To get the best deal on the GGBs issued by LCR, the issue had to be managed carefully in the run-up to the sale and the GGBs themselves had to be made to appear as Gilt like as possible.
2.21 The method used to price and distribute the GGBs was decided in consultation with the market. Three ways of issuing the GGBs were considered:
a) a straightforward auction through the UK Debt Management Office (lowest issuing costs but giving least control of the prices at which the GGBs would be sold);
b) a bookbuilding process in which a lead manager would invite bids at various prices to assess the strength of demand (possibly higher issuing costs than an auction but more certainty that all of the GGBs would be sold at managed prices);
c) an underwritten issue where one or more banks agree to buy any GGBs that remain unsold (the most expensive option although demand risk is fully transferred to the underwriters).
2.22 Early advice had indicated that an auction process would be acceptable to the market, provided the GGBs were made as Gilt like as possible. Two key conditions were required: that the GGBs would be accepted by the FTSE Bond Index Committee for inclusion in its Gilt Index and that the Bank of England should accept the GGBs as eligible for its market security operations. The FTSE Bond Index Committee rejected the inclusion of the GGBs as they were not Gilts. The Bank of England indicated that, consistent with its treatment of new types of financial instrument, it was unwilling to include the GGBs as eligible in market security operations until their liquidity had been proven through successful trading in the market.
2.23 As a result, investors did not favour an auction and expressed a strong preference that the GGBs should be issued as Eurobonds, either as a bookbuilt or underwritten offer. The Department, in consultation with its financial adviser, the Treasury and the Debt Management Office, opted for book building on the grounds of cost. Following a competition supervised by the Department and its financial adviser, SBC Warburg Dillon Read and HSBC were appointed by LCR as lead managers for the book building. At under half the cost of an underwritten offer, their fees were reasonable, given the large size of the issues, reputational risk and the need to support the GGBs in the after market if required.
2.24 Action was taken to make the GGBs attractive to the market. For example, to appeal to as wide a variety of investors as possible, the interest payment dates on the GGBs coincided with those on comparable Gilts maturing at similar dates. The GGBs were issued around the time that the Gilt markets were at their most favourable for the 12 months around February 1999. The interest rate margins over Gilts on the GGBs were lower than comparable AAA rated issues and the GGBs have generally performed well since their launch in comparison with those issues. Our overall conclusion is that the marketing and launch of the GGBs was a success (Appendix 5, paragraphs 55-98 set out the detail). In the longer term, this was also important in creating positive perceptions amongst investors ahead of any further bond issues by LCR for Section 2 of the Link.