8 | ifr special report | June 2008 SOVEREIGN BOND MARKETS ROUNDTABLE “
Europe differs in the method of price quotation as it operates on a decimal format, whereas US treasuries are still quoted in 32nds and 64ths, although there is certainly argument that the decimalised format is undesirable.
IFR: Have European government bond turnover figures remained consistent this year with previous years?
Angelo Proni (MTS): In our experience, and from what I understand as far as the other electronic trading platforms are concerned with respect to the outright cash market, the past two to two-and-a-half months have seen a fall in volumes. Whilst at the beginning of the year – and indeed actually in the run-up to the end of the year, despite the surge in volatility that was observed – volume still did pretty well. In fact it did much better than usual. Right now, however, the volumes are definitely weaker.
Jeffrey Hogan (BGC Partners): The voice volumes have remained very robust. From an electronic perspective, volumes have declined. As you might expect in times of high volatility, the voice market has been resurgent. Certainly since last August we have seen, as a percentage of the overall performance of the market, voice volumes enjoying a significantly greater share. I think, as we provide a service to the banks, we are fairly agnostic [about whether trades are brokered by voice or electroni- cally]. If the banks wish to trade by voice it is fine and if they wish to trade electroni- cally that facility remains available to them.
In Europe the market could be described as "fragmented", with multiple issuers compared to a single US Treasury issuer. Recently there have been articles in the press surrounding the ten year anniversary of the euro and the movement towards a single issuer, and we may see some discussion of the bill sector becoming unified in some fashion. But the treasury market is different because it became virtually 100 % electronic instantaneously, and there is also the existence of the high velocity, non-bank algorithmic operators in the treasury market which isn't the case with the European government bond market. This has the effect of maintaining the status quo and the reliance on interme- diation by voice brokers. Europe also differs in the method of price quotation. It operates on a decimal
format, whereas US treasuries are still quoted in 32nds and 64ths, although there is certainly argument that the decimalised format is undesirable. When the New York stock exchange and other equity exchanges moved from fractions to decimals, the actual amount in terms of volume of each transaction went down. So in terms of looking at the bid offer spread, the price appeared to be narrower, but in terms of size available there was a dramatic reduction. The size per order went down due to the fact the tick size was smaller. So I think in the equity world, most of the exchanges who experimented with decimalisation have concluded that, at best, it has been a mixed experience. That was because the providers of liquidity on a five cent bid/offer spread are much more willing to show size than if there is a one tick spread. By definition, each individual transaction at a tighter spread is going to be smaller. The specialists on the floor of the New York Stock Exchange – when there was a floor – reduced their liquidity dramatically, because of the desire to make markets on a one or two tick spread, which is clearly not the same as a wider spread. Certainly we have seen some of that in the European cash markets. In the Government markets, where we have all witnessed the changes in tradeable bid/offer spreads since last August, that parallel is exactly the same. The desire to maintain similarly sized markets when the underlying conditions have diminished is a challenge for the industry.
IFR: It was said that decimalisation had resulted in an increase in algorithmic trading in the equity market, was it not?
Hogan: Yes, though the average size per transaction is still lower. So you have a higher frequency and in equities the overall volumes have gone up, but the size per trade is not larger than it was previously. So I think it is a mixed bag. I think in the cash markets and the bond markets, and certainly in the Treasury market, there has been no call to arms to go towards a decimalised format.
IFR: What are your views on European sovereigns issuing in US dollar format? Both Spain and Italy have recently done this with deals that have clearly been driven by the movement of the basis swap. This was the motivation for Italy issuing in dollar format on this occasion, if not all occasions. One question particu- larly stands out: do you think the basis swap shift is a permanent or a temporary phenomenon, and why did it move in the first instance?
Ezquerra Martin: I have asked many different banks, because obviously it is not a market that we follow from the Treasury – we just look at the quotation and it is difficult for us to judge the underlying forces. But the most rational explanation I've heard so far is that European banks are having to fund assets denominated in US dollars, and cannot obtain funding in dollars. So they fund themselves in euros and reverse the position through the basis swap market by paying dollars. For European sovereigns who are accessing euros, on the other hand, we are interested in the opposite trade when we issue in US dollars.
So from this point of view, insofar as European banks have trouble funding themselves in dollars, they will maintain this trade and they should keep some pressure on the basis swap. That's the most rational explanation I've heard. I can't say I underwrite it fully, but what we did see was enormous volatility in basis swap spreads, because there's not the usual sort of arbitrage that takes place between asset swaps in the dollar market, the euro market and the basis swap.
IFR: Spain's five-year trade earlier this year was done at swaps less 28bp. I think there may have been an incremental 7bp or 8bp pick-up, or cost saving, because of the current level of the basis swap. Is that of interest to other European issuers?
Leclercq: If we look at the market, it seems to present a very good opportunity. We are looking at the market to really try to find out if we should follow this route: what we
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