Europe’s bond boom may stem investment bank exodus from sovereign debt auctions

LONDON: The surge in government borrowing during the Covid-19 crisis and boost in bond trading may stem investment banks’ gradual exodus from the less profitable business of buying and distributing European sovereign debt.

Several lenders such as Credit Suisse, Societe Generale and ING have in recent years scaled back primary dealerships — a role in which they run government bond auctions, sell securities on to clients and then actively trade them in secondary markets.

Industry officials cited lower profit margins and tougher capital and liquidity rules among the reasons spurring the retreat.

That has left the median number of primary dealers per country at just 16, the Association for Financial Markets in Europe says, from 20 five years ago.

The Covid-19 pandemic could mark a turning point.

European bond sales this year have soared to around 1.7 trillion euros ($2.1 trillion), up 80% from 2019 and levels are expected to stay buoyant for years. The consequent rise in daily trading volumes has contributed to double-digit revenue growth in the investment banking business.

Second, there is the allure of joining lucrative bond syndicates — where a group of banks underwrite a bond, then market and sell it to investors. Such deals, which can yield hefty fees, have more than doubled this year from 2019, raising almost 400 billion euros in European sovereign debt, Refinitiv data shows.

Primary dealer banks often have an advantage when syndicates are picked, and may also win other business such as helping local corporates or state-run firms raise debt.

“If anyone had known what was coming - any of the top 15 banks - they would have invested more in the sector because the fees have been big this year,” said a banker at a primary dealer for several European countries who declined to be named.

“(Being a primary dealer) has been an investment and it doesn’t always make us money,” he said, but added: “It helps our other franchises to say we are a leader in the rates markets - that’s the intangible benefit.”

Syndication fees are typically calculated as a percentage of the total issue. While details are rarely disclosed, banks managing Spanish and Italian deals in April picked up a combined 50 million euros, Reuters reported.

A primary dealership is a major undertaking, obliging banks to participate in auctions, hold bonds on their books and invest in infrastructure and technology.

So banks will sometimes make a strategic decision to ditch the role. ING for instance will discontinue acting for Germany and the Netherlands from Jan. 1, citing a need to strengthen its business amid “challenging market conditions”.

Denmark, Spain and Portugal also lost dealers this year.

Credit Suisse, which has exited most of its primary dealerships, declined to comment on whether it was re-evaluating its position. UBS which retains two dealerships — versus six in 2017, according to AFME data — also declined to comment.

There was a promising development in June when Lithuania added a new primary dealer. Britain’s debt management office (DMO) said none of its primary dealers have quit in the past three years.

There is now another inducement - the chance to win business from the European Union which may raise up to 900 billion euros over coming years.

“Think of a client like the EU, if you’re not very strong in sovereign primary dealerships it will be very difficult for you to win that business,” the banker said.

Losing primary dealers is a blow for governments because of their role in ensuring market liquidity, more so now when debt issuance is soaring.

Anthony Linehan, deputy director, funding and debt management at Ireland’s National Treasury Management Agency said primary dealers had been invaluable during the volatile trading period at the height of the Covid sell-off in March. That was before central banks stepped in and stabilised markets.

Despite the chaos, “primary dealers continued to make prices in government bonds and the market continued to function and trade”, he said.

That’s why many have made efforts to hold on to primary dealers. The Irish debt agency said it consults banks while deciding on the bonds it auctions, others were giving banks ample warning on auction plans and one has changed how it sets auction pricing to accommodate primary dealers.

Britain’s DMO generally holds smaller auctions, and in April decided to compress two auctions into a day to ease banks’ burden.

Primary dealers played a critical role in allowing Britain to quickly upsize debt issuance this year, DMO Chief Executive Robert Stheeman told Reuters.

Auctions comprise 90% of gilt sales, which “are hugely reliant on primary dealers as intermediaries”, Stheeman said. “It has been demonstrated for many years that a PD system is the most effective intermediation system to ensure this.—Reuters