The Covered Bond Report

News, analysis, data

ECB ‘doesn’t want to drive the price’, says coordinator

León Fernández Brennan, portfolio management expert at the European Central Bank, shared insights into the strategy of the APP “control room” at an AFME covered bond conference on Friday, including how it seeks to manage issuance seasonality and minimise price distortions under CBPP3.

He was answering questions from Bill Thornhill of GlobalCapital at the event, which is organised in cooperation with the vdp. The questions are abbreviated and the answers were run past the ECB ahead of publication.

Could you possibly tell us what your function is within the ECB?

I work in the bond markets and international operations division of the ECB. This is amongst other things the control room for the asset purchase programme, which entails the PSPP, CSPP, ABSPP and the third covered bond purchase programme, which I’m primarily involved with.

My role there is as one of the coordinating portfolio managers for the CBPP3. Day-to-day, this involves making purchases myself, but also coordinating a team of portfolio managers based in national central banks throughout the Euro area, who are buying bonds in the primary and secondary market on behalf of CBPP3. Ultimately it’s our responsibility to ensure that we hit our net targets for CBPP3 every month, and these fit into our new €20bn net target for the overall APP.

We are also involved in policy stuff, so in the design of programmes or in the updating of operational parameters, as we move from one gear to the next in the programmes. For example, as we moved from what we used to call the reinvestment phase, which was the year until the start of this month, to the new net purchase phase.

What has changed?

In one sense, not all that much has changed. The eligibility criteria remain as they were – nothing’s changed there. We are still active in the secondary and primary markets – a little bit more active in the primary market now, as I’m sure you are aware.

One technical change that we made, back in September, which was announced at the same time as all the other recent announcements – and which might have gone under the radar a bit so I just want to highlight it – is that we can now buy bonds that yield below the deposit facility to the extent necessary, which we couldn’t do in the past, so that’s one technical change.

But maybe more generally, one thing that’s different now compared to earlier in the programme is the level of redemptions we face. We publish all the data on redemptions on our website, so historical redemptions of covered bonds going back right to the start of the programme in 2014 and also, going forward for the next 12 months, month by month. One thing you can see if you look at these numbers is that if you look at the last net purchase phase, from the end of 2014 right through to the end of last year, you can see on average per month the redemptions we have to cover before we can even think about start making net contributions to our targets, that was around €870m on average. Now if you look forward for the next 12 months this jumps up to €2.5bn on average before we can make one euro of contribution to the €20bn. So that’s kind of a big change.

Is the ECB a price-setter or a price-taker? You have all these redemptions to fulfil, you’ve got €20bn a month of net purchases to make, so even if there’s a degree of price sensitivity, it feels like come what may you have to buy that amount every month. How do you exercise any degree of caution over what you’re buying?

When we’re setting targets, particularly for the private sector purchase programmes – CSPP, covered bonds and ABS – we try to do it in a way that we buy more when the market activity is higher. In months where we have high primary market issuance and high secondary market liquidity, we try to purchase a bit more, so as not to have to push things too hard in other months when liquidity and primary market activity is low and the potential for distortion could increase. So we try and go with the market to some degree and you’ll see our purchase activity will vary month to month based on the dynamics in the primary and secondary markets.

In addition, the overall €20bn a month, this isn’t €20bn every single month, this is €20bn on average over the course of the programme. So just as in the past when we’ve been doing €60bn or €80bn or whatever, this will vary, so that in the likes of August or December we’re going to drop down a little bit probably and then just make up for it in other months. Again, it’s all about being as market neutral as possible and minimising any potential for distortion insofar as we can. So yes, we’ll change the share to take account of the kind of market dynamics and also the overall level to take account of the market dynamics.

In terms of being a price-setter or going with the market price, we go with market prices. If we can’t trade on market prices in a particular pocket of the market, we’re not forced to. We’re adaptable. We can look at other market pockets and we can be flexible over time.

How do you manage the fluctuations in issuance in respect of what you need to buy?

As I mentioned at the start, we have teams of portfolio managers in national central banks across the euro area, and they have a great deal of local market knowledge and insights in terms of when they expect issuance to come in their local market, more so than we do sitting in Frankfurt. So we rely a lot on their expert judgement and local knowledge, in terms of guiding our purchase targets and our pace of purchases throughout the month and so on. That’s one thing.

And the second is to emphasise that, one of the key things for the programme – for all four elements of the programme – is flexibility and adaptability. So if the month or the quarter doesn’t turn out exactly as we anticipated ex ante we’re flexible, and all elements of the programme are flexible and adaptable and we can adjust to the reality of how the month progresses in terms of the market and issuances.

It appears that sometimes the ECB comes relatively late into the bookbuild, and people have welcomed that because it means that the private sector has at least started to anchor orders and you’re following – is that deliberate?

We don’t in any way try and come in late. Sometimes, given that the ECB and the Eurosystem more generally is quite a large institution, it can move a little bit slowly and it might take a little bit of time for us to get the bid in as we have to do various checks to make sure things are eligible – we don’t want to buy bonds that aren’t eligible. So sometimes that can take a little bit long. But we try and get the bid in as soon as possible. And generally speaking I think we do get the bid in quite quickly. We don’t want to make the job of the bookbuilders any more difficult than it already is. They have a hard enough task as it is, so we don’t want to make it worse.

In terms of how we operate in the primary market, we don’t want to be the one driving the price. Obviously we’re a large bidder, but we like to see the private sector driving the price. So if we see the price tightening in a manner that’s reflective of the overall demand for the bond, that’s perfectly fine with us. However, if we see prices tightening a huge amount, and this isn’t in any way corresponding with the level of demand, we reserve the right to reduce our bid or in extreme circumstances to withdraw it, but in practice, as our interests are aligned with those other investors this scenario has been purely hypothetical so far.

Would it be hypothetical in a situation where you see a deal creeping over the line?

Well we have to be fair to all issuers, so we have a standard bid which we usually stick to. If a deal is creeping over the line we’ll still apply that bid – we can’t go and take, say, 90% of an issuance just because the private sector demand isn’t there. Of course we won’t reduce our bid unless the pricing is completely unjustified by the other investor demand.

E-mail this article's headline, intro and link

Leave a Response

Please note: comment moderation is enabled and may delay your comment. There is no need to resubmit your comment.