Sovereign Bond Markets Roundtable 2008: part three
IFR:Does this work in extraordinary circumstances? So, for example, at the height of the crisis when there were, and still are balance sheet constraints with banks unwilling to provide liquidity even to each other, should they be expected to market-make even sovereign, agency or covered bonds?
Maisey: For some of us it is not just about our appetite to provide liquidity. For us, our balance sheet hasn't changed through the whole thing, but for lots of our clients it has. So it is not just about, if we are prepared to do it, it is also about whether people on the other side who want to take risk, or we can lay risk off too, or where we can source bonds from. So it is not just about bank appetite, it is about investor appetite as well.
Leclercq: The issuers are also trying to promote their own transparency and the way to do that is also a factor. Before the crisis, we looked at volumes: we looked at volumes and we appraised our primary dealers accordingly, depending on the volumes they traded in the market. We differentiated between customer volumes and voice traded volumes, the former of which weren't on the electronic platform where the market-making obligation existed. When you look now at how we appraise our primary dealers, we base it on their compliance to their quoting obligations. In other words, how are they doing, are they compliant or non-compliant? We look also at volumes to some extent, but one of the major points which we look at is are they compliant, and can they be over-compliant, can they be better, can they do something better? So we have switched to a different way of thinking, we have focused on, as Erik said, trying to give price transparency to the market and I am really convinced – as Erik is also – that the only way to have price transparency, is to have your primary dealers making markets. It is really that change of appreciation which is probably going to lead to better transparency. At least, we hope so.
Rivoire: If I may, I think that you will appreciate the change in our position with regard to compliance, but the business done with the clients is another area which we consider to be our first goal. It is more important to offer good liquidity to clients rather than to the market.
Maisey: I agree, and then we could look at the question of compliance. Meeting investors' requests would be another very important area to look at.
Leclercq: Compliance is one thing and looking at customer volumes is another.
Proni: The two should be interrelated.
Leclercq: You have such a large array of different things which you do, and we look at every single little thing. But instead of only looking at the bonds which you trade within the inter-dealer market, we are looking now at how you are complying with your market-making obligations and making sure that there is transparency and there are continuous prices. So it is shifting a bit from volumes in the inter-dealer market to making sure that there are prices all the time. But we continue to look at customer volumes.
Maisey: I think it is not just about customer volumes, it is also about compliance: supporting the investor base, in terms of when they want a secondary market price. So it is not just about volume, it is about the obligation we have to investors as well other things such as research.
Rivoire: On the repo question as well, especially when the money market is changing, to be able to offer to clients repo prices for any security they have, especially in the sovereign sector, is a very positive development I think.
IFR: While cash trading has diminished over the last couple of months, have the changes which were announced by Holland and Belgium, impacted the level of repo transactions at all?
Proni: From the MTS standpoint, with respect to the repo market, it remains in fairly good health for reasons tied into what's going on. In that respect MTS doesn't really have that many concerns. As far as the changes that you mention with respect to Belgium and the Netherlands, in terms of the multi-platform environment, I'm assuming we are also talking about the soon-to-be-implemented introduction of similar measures in France.
Clearly when you are the incumbent and a franchise disappears, you are going to suffer a bit, so obviously we have fewer banks quoting those bonds than we had previously. By definition, that was going to happen. With respect to the actual business and number of participants concerned, I would tend to say that not an awful lot has changed if you discount the effect of current market conditions. In this equation, we have had the introduction of two elements of freedom: the introduction of a choice to the dealers of what platform they wished to quote on, which was intentional from the issuers; and the actual uncertainty in the market in general. The latter is probably the main culprit as far as the fall in volumes on the electronic platforms is concerned. Based on the information that I have, it's not only MTS that is suffering in terms of cash market volumes but most of the electronic trading platforms.
So I think MTS has addressed the challenge of the multi-platform environment in the best way that it could, essentially by maintaining the principal strategy of ensuring that we could maintain the quotes of the primary dealers for compliance purposes with issuers on the MTS platform. If we can achieve that, which so far all the indicators are saying we have – although it is still very early to really draw any final conclusions – then I think the rest should be pretty much in hand.
Ezquerra Martin: In Spain it was the other way around, because MTS was the challenger, not the incumbent, back in 2003. So it's strange to see the situation in reverse. We introduced MTS as a second platform back in 2003 before it became so prominent in the European government bond market. We are also considering introducing further flexibility to our system by introducing potentially a third platform but, frankly, we are not in a hurry because the situation is a bit challenging and we also want to look into some final details – such as what measures might be necessary to maintain liquidity in emergency market situations – before we introduce the platforms of our potential new entrant. For now, with volumes falling so significantly, we are in no real rush to do this. We are looking at it and we are addressing the problems one by one. Overall, I agree with the view that when you introduce a new challenger, things seem to change radically, but in the end they are more or less the same.
Proni: That's assuming the incumbent has done a half decent job in the beginning, which I would like to think that MTS has.
Ezquerra Martin: Exactly, and our incumbent seemed to be doing that. So things need to change so that they remain the same at the end of the day.
IFR: We have had the suggestion that there has been more participation at the auction level from end investors with yields at the highest levels of the year so far. How has the role of hedge funds changed in terms of involvement in sovereign debt and have they become more important from the point of view of sovereign issuers?
Wilders: I think we haven't issued for a month now, or over a month, and it would have been a tap, so we wouldn't be able to see the details of hedge fund participation. Going back to the DDA, we saw different investors, and more real money investors, than we had ever seen previously in terms of both numbers and new accounts. For example, we saw private banks for the first time in our experience, which means that somewhere private individuals, wealthy private individuals, thought, "Well, it might be safe to invest our money for a while in government bonds", and probably, if the cycle turns, they may go again and we will see different buyers coming in.
For us it's very difficult to say, "I want to target one specific group", as long as we are open to as many investors as possible, there are always some that are willing to buy, given current circumstances. That's what we hope to achieve, and as a result hedge funds are welcome, private individuals are welcome, and all investors in between.
Ezquerra Martin: Well, they are more flexible, as Erik was saying, within syndications or DDAs or whatever. Certainly, looking at the numbers, not only in our deals but in others, their participation has diminished. No longer do you see these overwhelming bids in the books of syndicated deals, which were hard to believe. Now they are more low profile. But, fortunately, their place has been taken by other types of real money, pension funds and insurance companies, which used to have a much lower level of participation. So, at the end of the day, I think that perhaps their impact might be more detrimental and more visible in the falling volumes in the secondary market than in the primary, because in the primary market it is just a matter of substitution, really.
Rivoire: I think, in the secondary market, we have clearly seen in the last few months less activity from hedge funds, mainly due to the refinancing considerations. Due to the tensions we have in the money market, all the prime brokers have slightly, or dramatically, changed their refinancing conditions. So it is definitely more costly to enter into a position: if you look at the average leverage of the hedge funds, it has dramatically decreased in the last few months. Obviously the liquidity and the bid offers are slightly wider than they were, and it means that, for all these reasons, things are more challenging for them to enter into new positions.
What are the consequences for the secondary market? I think that the hedge funds obviously remain in the market, especially in terms of relative value trading, and due to the fact that they were ready to buy and to sell to take advantage of the pick-up, et cetera. The effect of this will be to contribute to the normalisation of the European curves, in the same way that they operate in the US Treasury market. Although, due to this lack of participation on the part of the hedge funds, it is clear that the relative value element is more challenging. A lot of market participants – not only hedge funds but some US investment banks as well – have dramatically reduced their presence, which means they are not in a position to take advantage of even the smallest pick-up the market is offering. This is because it might be too costly in terms of refinancing as well as costly in terms of managing positions in this environment. Though, and as Erik has said, fortunately we have seen some shift from the hedge funds to real money interest and especially reserve managers, as well as more interest from bank treasurers. But in terms of relative value especially it has clearly changed the way the secondary market is working.
Maisey: In addition to the financing costs the bid offer spreads are wider, so some trading opportunities or ideas have disappeared or are no longer profitable for hedge funds, which is an integral part of their business. I also think now might be the perfect time to try and push for further changes in the way the market operates, for example the introduction of new participants. The market has been in a state of some flux and I think this may encourage new platforms which in the long run will help a faster return to normality. So we actually think that this is a great time for a more competitive environment in the dealer-to-dealer space and to see what other platforms can come up with in terms of ideas, technology and innovation, particularly in terms of fee innovation.
IFR: Does diversification across platforms actually increase the total volume in the market or just divide it between different competing platforms?
Maisey: The big risk, in my opinion, is you end up fragmenting the market and that could be detrimental. That is a big risk if you have too many platforms, and I think in all electronic markets there isn't room for an unlimited number of platforms, so you generally are only going to have a small number. Probably only one, two or three electronic platforms are viable. But I think the advantage of more competition really lies in innovation – particularly fee innovation and technology, trying to find some new ways of trading that will bring in more accounts. Alternatively it may mean that investors can manage their volume better, or find new trading ideas. With a lot of those things, it is hard to predict what's going to happen, but some competition will always lead to improvement and ultimately advance the market.
Hogan: It is still early days and it is important to remember that the MTS model has been in place for ten years. I think the benefits to the marketplace in general from the multi-platform environment has been the change to the rules and the change of the contract between the primary dealers and the issuers in the sense of monitoring performance. I think the movement to multi-platforms has also allowed the issuers to change the terms of engagement with the primary dealer community. Specifically in terms of how the dealer community is measured, and in terms of shifting from measuring the primary dealers in an absolute sense to measuring them in a relative sense, which has brought liquidity back on the screens. I think if we hadn't moved into a multi-dealer environment, those changes probably wouldn't have taken place and the markets generally would be less liquid today than they have turned out to be. So I think the success of the multi-platform environment hasn't necessarily been the shift of business between the platforms, but it has been the fact that there is an electronic business at all, given the problems over the last six months. The business is firmly back up on the platforms because of these associated rule changes that probably otherwise wouldn't have been implemented. Do you think that's a fair statement?
Wilders: I think we would have seen changes and I agree with you that it's easier to discuss the changes in the context of the primary dealers. I am the issuer and I am asking something from the primary dealers. I am trying to give them something in return, so it helps to have those discussions with the primary dealers.
I think the first steps were already under way in the MTS galaxy, although discussion was a bit more difficult there than discussions directly with the primary dealers. In that respect, I think it helps that we have direct communication with our primary dealers, so we can decide something together and that's separate from the question of the electronic trading platforms. I also strongly believe that competition between platforms will generate innovation and I hope that in the end that will help liquidity. That was a strong motivation for us to look at changing the landscape to allow more than one platform. I think the benefits from having competition are much larger than the risk of reducing the liquidity on our bonds.
So at this point I think we are going in the right direction, but there is still a lot which needs to happen. There is a strong belief that this will change the landscape and then we will see which will be the prevailing outcome for a while again and then, after a few years, it will change again. But I think this will help change things at this moment, and in that respect the timing is good. We considered whether the timing was bad to change now, but following discussions with the primary dealers, who were busy at their desks, et cetera, we decided to proceed. In the end it is always a lousy time for someone, although it is better to look at it from a positive point of view. We started thinking about implementing changes two years ago and who could predict what the market would be like at this point. So like your story, it is always a good time.