European sovereigns come to terms with poorer liquidity

Debt management offices need to provide more incentives to primary dealers

Market volatility has hit European sovereigns hard, with government bonds in the region suffering from lower trade volumes in the secondary market and wider bid-offer spreads.

Speaking at OMFIF’s team Europe borrowers seminar on 25 October, Tammo Diemer, member of the management board at Deutsche Finanzagentur, the German debt management office, said wider bid-offer spreads and lower trade volumes of German government bonds were ‘a reflection of the higher volatility’ and a ‘natural reaction of market participants to this situation’.

While there is still ‘very good demand’ for Bunds, Diemer added that ticket sizes were smaller. ‘We run much more tickets per day than in the past in order to sort of distribute the same amount of funding.’

These views were shared by other European sovereign DMO heads during the seminar.

‘This is a very serious issue that we are facing too and I have to say it’s something we look at very carefully because the liquidity on the secondary market for us has always been a crucial driver for a sound funding activity in the primary market,’ said Davide Iacovoni, director general of public debt, ministry of economy and finance, Italy.

Iacovoni said volumes of Italian government bonds (BTPs) traded in the third quarter of 2022 were in line with volumes traded in the third quarter of 2020, during the peak of the coronavirus pandemic.

BTP bid-offer spreads were also in line with levels during the second and third quarter of 2020, said Iacovoni.  ‘However, the situation is not homogeneous across the curve,’ he said. ‘For example, the points of the curve that are covered by future contracts tend to behave better in terms of the bid-ask spread, basically because dealers have these hedging tools that they can use and so these tend to help in this case.’

Iacovoni said one way they are trying to improve liquidity in the secondary market and tighten BTP bid-offer spreads was thinking about providing more incentives to primary dealers.

Cyril Rousseau, chief executive of Agence France Trésor, the French sovereign DMO, said when markets are volatile and risky, it was better for bid-offer spreads to be adjusted than ‘to force liquidity’ from primary dealers.

Meanwhile, Karen van der Wiel, head of policy and risk management at the Dutch State Treasury Agency, said they had ‘struggled’ this year to maintain a balance between incentivising primary dealers while taking into account market circumstances.

Van der Wiel added that labour market issues were also affecting the efficient functioning of European government bond liquidity, with primary dealers finding it difficult to hire good traders.

In a recent poll conducted by OMFIF’s Sovereign Debt Institute, 75% of public sector bond market participants said they believed European sovereign DMOs needed to provide primary dealers with more incentives to boost the liquidity of government bonds.

One other way European sovereign DMOs are trying to boost liquidity is via the repurchase market, something Patrick Barbe, head of European investment grade fixed income at Neuberger Berman, said was key, with the ‘repo market becoming more important’ for sovereigns.

The Finanzagentur recently announced plans to tap 18 outstanding bonds for use in the repo market and to support the overall functioning of the Bund market, providing it with additional flexibility to cover its huge financing needs.

‘Tapping those 18 bonds was in reaction to observing that there is this need for collateral,’ said Diemer. ‘Those 18 bonds are particularly expensive and are particularly demanded in the repo market.’

Burhan Khadbai is Head of Content, Sovereign Debt Institute, OMFIF.

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