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10 | ifr special report | June 2008 SOVEREIGN BOND MARKETS ROUNDTABLE

everyone was in a year ago. A lot of lessons have been learned, people won't just go, "great, we are back to how we were". The other thing is there is a lot of demand for very high quality dollar paper. But a lot of these investors are buy and hold, which results in less secondary market trading because people have generally bought those issues in the primary market and just hold them to maturity.

IFR: With regard to covered bonds in particular, they were positioned as a rates proxy to investors and were traded on the electronic platforms which came to an abrupt halt at the end of last year. Can this liquidity be restored on the electronic platforms do you think, and in what way can that be achieved?

Proni: I think eventually it can. The real question is how and when. I do not believe that it be restored in a timeframe that we think is both realistic and acceptable and the main question, especially for MTS, is: can it be restored according to the old market-making model, or do we have to adapt to a new reality and find a new paradigm according to which we can actually achieve the kind of liquidity that we had achieved previously?

For the time being, given that covered

bonds have been perceived by the investor base previously as proxies for government debt, the fact that they are no longer perceived as such has to account for the new reality. This is pretty much an immaterial point as the prices speak for themselves. The change in perception is going to take some time to revert – if, indeed, it ever does. MTS has been involved fairly closely with the covered bond industry and has attended a number of meetings with the individual banks, the individual issuers, as well as the ECBC. We are in the middle of seeing if we can devise, together with the market, a way to slowly re-establish that liquidity. The first thing that MTS has done on its own is to get rid of the previously more rigid approach requiring banks to commit to providing liquidity in the market and giving them a bit more of a free reign. Namely, the requirement to post prices according to a maximum bid offer spread in minimum sizes, which as far as covered bonds were concerned, was actually restricted to certain securities that had a minimum amount outstanding and other

sorts of objective criteria, has now changed. We are moving towards what some sovereign issuers have done in Europe with their own issuers to a certain degree, giving the banks a bit more freedom to make their own best efforts in order to try and re-establish some semblance of liquidity.

The first thing that MTS has done on its own is to get rid of the previously more rigid approach requiring banks to commit to providing liquidity in the market and giving them a bit more of a free reign.

Lately, activity has started to come back into the electronic market place. Obviously we are still quite a long way off getting back to where the market was a year ago, where the product was perceived as a potential rates proxy. Of course, covered bonds are different to mortgage backed bonds, but the investor community at large is no longer perceiving it that way and I think it's going to take some time before this situation changes.

IFR: Is it the case that liquidity also fell dramatically in the agency market?

Proni: Yes, although not to the same extent. Agencies are somewhere in between, although it depends on what is meant by liquidity drying up: there is a question of degree here. Obviously sovereigns have still remained by far the most liquid instrument – much less compared to what they were before, but much more relative to the other asset classes than previously. So I think there is also a question, not only in principle, but of the degree with which you look at this and analyse the situation.

Wilders: I think it depends on the proxy that you use: if you take electronic trading in the inter-dealer market, which eventually increased, and the spreads that

people pay is related to cost, what does that say about liquidity? Or you look at the overall volumes – and I think I can speak for all of us – in our market they were relatively high. If you look at the spreads versus corporates, et cetera, then it means that accounts must have been better buyers, so we must have had liquidity. So it is a question of how it is measured. All in all, I think the government bond markets functioned relatively well, albeit at levels that we have not been accustomed to previously.

Maisey: I think that there is more differen- tiation. Some types of bonds have totally disappeared, while volume in high quality government bonds hasn't really dropped, although some of it may have moved off the electronic trading platforms and on to a voice basis. I think those things will come back. I don't think that's something where you can just flick a switch and it goes back to where we were – it takes time, and people are nervous and they are going need a gradual re-introduction. Maybe now it is a good opportunity for new models to come out, new ways of trading things that answer particular needs.

Hogan: I think the covered bond and agency markets are suffering, if that's the right word, from similar concerns that affected the EGB market over the last 18 months and I think the solution will also be in the form of prices moving back onto the screens. To have the covered bond and agency markets trading over the phone will not be sufficient to restore investor confidence in the marketplace.

Proni: That is the difference between the sovereign and the covered bond market: the latter has almost disappeared, while the former has actually moved in terms of the location at which liquidity can be found.

Hogan: Because the sovereign universe consists of a smaller number of issuers, the situation is somewhat easier to resolve, whereas the covered bond market consists of a multiplicity of issuers from numerous different jurisdictions.

Wilders: I agree that the transparency is the most important thing. It is necessary to have a starting point, even though it may not be possible to trade from that starting point. We have asked our primary dealers to have an arbitrage free inter-dealer price

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