What it means
Countries sometimes agree to pool resources and set up an organisation to pursue shared goals, such as development finance, trade or stability. The resulting body has its own legal identity, its own charter and a governing board made up of representatives of the member countries.
Because it belongs to many governments at once, it is called supranational. In finance, supranationals are best known as lenders and bond issuers.
A development bank, for example, borrows from the capital markets at low rates and lends to governments and projects, often for infrastructure, health or education. Because these institutions have strong backing from their members and prudent financial policies, many are rated at the highest credit level.
Their bonds are popular with central banks, pension funds and insurers that want safe assets. They usually pay a slightly higher yield than the bonds of the safest governments, but less than ordinary corporate bonds.
The extra yield over government debt is the yield spread, and it reflects the small differences in liquidity and structure. Supranational bonds are issued in many currencies and maturities, and the institutions often raise money for lending in markets where they have a funding advantage.
They then use swaps, which are agreements to exchange payments, to convert the proceeds into the currency they need. This makes them frequent and sophisticated participants in global markets, and their issues are often large enough to be watched by bond investors everywhere.
The nuance is that supranational does not mean risk-free. The strength of a bond depends on the institution's capital, the support of its members and the quality of its loans.
Investors still analyse these factors, and a change in member support could affect the credit rating.
In practice
Real-world examples.
Example
A pension fund needs safe assets to match its long-term liabilities. It buys a 10-year bond from a regional development bank because it offers a slightly higher yield than government bonds with a very strong credit rating.
Example
A central bank invests part of its foreign exchange reserves in bonds issued by a multilateral lender. The bank values the safety of the investment and the fact that it can be sold easily if cash is needed.
Example
A country builds a new water system with a loan from a development bank. The loan comes with lower interest rates and longer repayment periods than commercial banks would offer, plus technical help in running the project. The government also gains an outside check on how the money is spent, which can improve the quality of the build.
Formula
Calculation
Yield spread = yield on supranational bond - yield on comparable government bond
Suppose a 5-year bond from a development bank yields 3.65% and a government bond of the same maturity yields 3.50%. The spread is 3.65% - 3.50% = 0.15%, or 15 basis points. A pension fund investing $10,000,000 earns an extra 10,000,000 x 0.0015 = $15,000 a year compared with the government bond. The extra income is small, but it is received without a large increase in credit risk.Case study
Seen in the real world.
Atlas Reserve Management is an illustrative, fictional investment manager that looks after $800 million for a group of public pension schemes. The board wanted to reduce risk but also needed a little more income than short-term government bonds provided.
The portfolio manager proposed moving $100 million from government bonds into bonds from supranational lenders with similar maturities. She showed that the yield was on average 0.20% higher, which would add $200,000 a year to income, and that the bonds were highly rated and easy to trade.
The board approved the switch with limits on the size of any single issuer. A review date was set for twelve months later, to check that the extra income justified the added paperwork. In this illustrative story, the extra income came with only modest additional risk, but the manager also warned the board that the spread could widen in a market crisis.
Watch out
Common mistakes.
- Assuming that supranational bonds are completely free of risk, when they depend on the strength of the institution and the support of its members.
- Confusing a supranational body with a national government agency, which is owned by a single country.
- Overlooking liquidity, since some supranational bonds trade less often than government bonds and can be harder to sell quickly.
Questions
People also ask.
Which organisations are supranationals?
Examples include the World Bank Group, the European Investment Bank, and regional development banks such as the Asian Development Bank and the African Development Bank.
Why are supranational bonds highly rated?
Their members stand behind them, they hold substantial capital and they follow conservative lending and funding rules.
Why do supranationals issue bonds?
They borrow in the capital markets to fund loans for development and other public purposes, instead of relying only on money from member governments.
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