Four banks have exited the European Union’s primary dealership group since last September, signalling that smaller-sized banks are struggling to keep up with the costs and obligations in maintaining their roles as market makers for the EU.
Between September 2022 and January 2023, ABN Amro and Jefferies left their roles as EU primary dealers, with Norddeutsche Landesbank and Rabobank following suit earlier this year.
‘We have been talking about the stresses on the primary dealership model for years and now with the EU, another PD group has been set up,’ said a head of sovereign, supranational and agency debt capital markets. ‘Many of the smaller banks are struggling to break even. We’re one of the EU’s top dealers for secondary market activities as we do an awful lot of flow and we do well in auctions, which helps us get syndications. But if you just look at it from the pay-off from syndications versus auctions, we just about break even from the money we make from being an EU primary dealer.’
Even though the EU has set up low barriers to formally become a primary dealer, the pressure for banks lies in knowing that every bank must bid in every auction with a commitment to buy a minimum of 0.05% of the volume to be auctioned. As the EU is increasingly doing more auctions, this is putting strain on banks.
‘Even if you don’t buy a huge amount in auctions, there are still a lot of costs involved,’ said a second head of SSA DCM. ‘Plus there’s no guarantee of getting a benchmark mandate, so for smaller banks, it has to make sense. More banks will drop off. In other large European primary dealerships, there are 10-15 banks. You don’t need 40 banks to make a market. The Finanzagentur has 36 primary dealers, but it has zero obligations – you don’t need to show up for auctions.’
The EU has 39 primary dealers – the same number it started with when it launched its primary dealership programme in 2021 due to the additions over the last few years from CaixaBank, Cecabank, Eurobank and Raiffeisen Bank International. But the feeling is that more of the smaller banks could leave, particularly as the EU ramps up its obligations on its dealers as it progresses towards sovereign status.
‘The EU is going to add more and more things,’ said a head of SSA DCM, referencing the incoming quoting commitments the EU is introducing to support secondary market liquidity. But as Siegfried Ruhl, hors classe adviser to the director-general for budget at the European Commission, explained at the launch event of the Public Sector Debt Outlook 2023 report by OMFIF’s Sovereign Debt Institute earlier this year, the quoting commitments will not be an obligation, but rather a rewarding system to gain points for eligibility on mandates.
As well as introducing quoting commitments, the EU is taking other steps towards emulating European sovereign borrowers as it inches closer towards sovereign status. From 29 June, the EU’s bonds will be classified under haircut category I, the same as government bonds, and making them more favourable for use in repurchase transactions with the European Central Bank. The EU is also planning to launch the EU Issuance Service in August 2023, allowing the settlement of EU bonds to take place in the Target-2 system, as is the case for EU sovereign bonds.
The EU is looking to create a futures market, which could be in place as early as next year. ‘The original plan was to launch a futures market in 2025 or 2026 but bringing it earlier would be better,’ said a head of SSA DCM. ‘With more and more outstanding debt, the easier it is to develop a futures market.’ However, a head of SSA syndicate warned that the EU should first look to boost the liquidity in the 10-year space of its bonds, which is the basis of a futures market.
Siegfried Ruhl, along with leading funding officials at global SSA borrowers and senior portfolio managers, will be speaking at the Public Sector Debt Summit, the annual flagship event by OMFIF’s Sovereign Debt Institute, on 23 May in London. Click here to explore additional speakers and secure your spot at the event.
Burhan Khadbai is Head of Content at the Sovereign Debt Institute at OMFIF.