The ECB's massive bond-buying programme has fuelled a bonanza in euro zone sovereign debt, with some investors vastly overstating their orders at debt sales in a bid to secure the coveted paper. But now some governments are starting to say, enough is enough.
Borrowers including the European Union, France and Spain are moving to rein in orders from hedge funds in their syndicated bond sales, a government official and four banking sources involved in the deals told Reuters.
The aim is to stem a deluge of inflated orders from these funds, which vastly overstate their demand in an attempt to guarantee they secure their desired amount of bonds, according to the sources.
"The concern is that if you don't have the correct picture, you might make mistakes in the future about what the actual demand for the bonds is," said Stelios Leonidou, who manages Cyprus's debt issuance. He told Reuters he had raised the issue with banks, though did not say Cyprus planned to curb orders.
The investor rush to snap up sovereign debt is being partly driven by the European Central Bank's immense presence in the secondary market, where it's 1.85 trillion-euro ($2.2 trillion) pandemic war chest to shore up the euro zone economy is making it harder for investors to find bonds to buy.
The likes of hedge funds and some other investors are looking to make a quick profit by buying bonds in government sales and flipping them to the ECB for more.
Order inflation has become so extreme of late that government debt management offices are pushing back. Two bankers said they had at times seen hedge funds putting in orders that exceeded the totality of the assets they managed.
The European Union has been capping orders, mainly from hedge funds, since the beginning of the year and France did so in a March deal, according to the bankers, who declined to be named due to the sensitivity of the matter and did not specify what the level of the caps were. Spain also limited such orders in February, the sources said.
The strategy involves having managers at banks explain to the buyers during the sale process that the borrower would be capping their orders, meaning bids exceeding that cap would not be taken into consideration, the people added.
"The message was: you're not going to get any benefit from putting orders above a certain size," said one of the bankers.
A spokesperson for the European Commission said it uses an allocation policy in line with EU securities law.
France's debt management office told Reuters there was no specific cap on the order size but that banks were instructed to make investors understand it would be amenable to orders "more in line" with what they could reasonably expect to receive.
Spain's treasury said its order cap has been in place for several years and that it applies "uniformly across categories of investors".
The ECB declined to comment.
STIMULUS SIDE-EFFECTS
Sovereign bonds are a necessary asset for many investors, which need them in portfolios to manage risk and returns.
Some hedge funds and other investors also trade in the bonds, making it easier for the debt to be bought and sold in the marketplace.
However the ECB's bond-buying since 2015, which it has stepped up during the pandemic, has created an investor rush that has led to supply shortages.
Eight euros of demand chased every euro of syndicated government debt in January this year, Reuters analysis of Refinitiv IFR data shows, versus two euros in January 2015.
Order books routinely exceed the funds raised by over 10 times; last October's European Union 17-billion-euro issue set a record, drawing 233 billion euros in bids.
Even junk-rated Greece saw a 26-billion-euro order book at a recent 2.5-billion-euro sale of 30-year bonds.
For hedge funds - who are allocated a relatively small chunk of bonds by issuers - the supply-demand imbalance means they often get far fewer than they ask for, so they order more than they need, according to the interviews with bankers and government officials.
This makes it difficult for governments to gauge the true demand and can make it appear that they have underpriced the debt and are not delivering value, even though much of the demand is illusory.
Britain's Treasury Committee wrote to its debt management office in November, for example, demanding to know how it ensured pricing was "keen enough in favour of the taxpayer".
Buyers are "almost incentivized to inflate their orders to get a reasonable allocation", said Gareth Hill, a fund manager at Royal London Asset Management.
One hedge fund manager, who requested anonymity, said that after inflating his order in the recent Greek issue, he received only 3% of his order. "We didn't get enough," he added.
'COMPLETELY PREPOSTEROUS'
Before the ECB's bond buying, hedge funds would only bid in issues if they had a specific interest in the deal, one banker said. "Now, it's all these players getting involved systematically in every transaction".
In January, for example, a 50-year French bond sale saw 75 billion euros in bids. Requin, the debt management office head, estimates over 80% were from hedge funds and other so-called relative-value accounts - investors who sell the bonds on quickly, also known as "fast-money" accounts.
The numbers were "completely preposterous", he said. "They don't reflect anything," he added.
The same month, after receiving a 130-billion-euro order book, Spain's debt management office cut the yield it offered on its bond more sharply than usual. Bond prices go up when yields fall.
Over half the orders then vanished, an experience which bankers said spooked debt management offices. Spain's treasury director general Pablo de Ramon-Laca blames it on hedge fund-type bidders who might have found it harder to profitably flip the paper after the price hike.
Most "real-money" investors - those such as asset managers and pension funds who hold onto bonds for a longer period - accepted the tighter price "but a good many fast-money accounts found that this reduced their profit unbearably", de Ramon-Laca said.
At France and Spain's most recent deals in February and March, headline orders did shrink considerably.
Still, the Spanish and French bonds were oversubscribed 13 and five times respectively. Last week's 13 billion-euro EU deal drew nearly 100 billion euros of orders.