MNI INTERVIEW: ECB Bill Sales Would Ease Collateral Drought

The European Central Bank might issue bills to ease the collateral shortage facing eurozone money markets at the end of this year, a senior director at a bond industry trade association told MNI, adding that last week’s EUR100 billion increase in the ECB’s Securities Lending programme will bring only marginal improvements.

The increase in the securities lending limit to EUR250 billion still leaves the facility very small in comparison to the size of the Eurosystem’s balance sheet, which holds a high proportion of the eurozone’s high-quality assets, said Andy Hill, who oversees repos and collateral as a senior director at the International Capital Markets Association.

Nor will recent moves to speed repayment by banks of ECB TLTRO loans do much to ease shortages of German, French and Dutch government bonds needed by market participants to pledge against loans, Hill said, though he acknowledged there might be a boost to supply of covered bonds as well as Italian and Spanish debt.

T-BILLS

With the Eurosystem holding EUR4.6 trillion in excess reserves, ICMA has been lobbying the ECB for bolder steps to tackle the collateral drought, with possibilities including offering reverse repos as does the Federal Reserve. But such a facility might be difficult to implement in the eurozone, noted Hill, adding that he suspects the ECB might instead be looking at issuance of central bank T-bills or notes.

“The ECB could issue short-term notes, one-month or two-month notes, or even a shorter duration. They could do this either on a persistent demand basis or it could be on a regular auction basis,” he said.

A bill programme would provide high-quality liquid assets for short-term investment purposes, would be easy to liquidate to cover margin requirements and would soak up excess reserves, he said.

“The other benefit of T-bills is that you are less reliant on bank intermediation,” said Hill, noting that eurozone money market funds, unlike their U.S. counterparts, are unlikely to have direct access to the central bank and so rely on banks whose capacity for intermediation varies during the year. “T-bills would get around that problem because banks may still have to intermediate, meaning they would still have to buy and sell these bills, but they would not sit on the balance sheet once they sold them.”

Complementary to a bill programme might be for Eurosystem central banks to adjust limits on specific bonds that can be lent under credit lines with bank counterparties.

“That’s an area where there needs to be a conversation before the year end,” Hill said.

When asked about the size of potential new measures, Hill pointed to the Fed’s repo programme as a guide.

“It’s a difficult one to guess, but if you look at the U.S. reverse repo last year, it was EUR1.9 trillion over year-end,” he said.

BONDS AT NATIONAL CENTRAL BANKS

Directly emulating the Fed’s reverse repo programme, though, may not be the answer.

“The tricky thing is that, unlike the U.S. or the UK where you have one central bank holding all the bonds, in Europe you have lots of central banks holding all the bonds, so it would be very difficult to coordinate. In the eurozone, the ECB holds some government bonds, but most German government bonds are held by the Bundesbank, most OATs are held by Bank of France and BTPs are held by the Banca d’Italia,” Hill said. “I think that is probably the reason why the ECB is not keen on it. It is not a failure to recognise the issue, I just think that, from a technical perspective, it would be very hard to implement.”

Meanwhile, money markets await new measures to tackle the collateral shortage, particularly as year-end approaches.

“This is when we get a big problem, when we get very big dislocations in rates, and it becomes very punitive to be long cash,” Hill said.

While banks can simply close their books, money market funds or pension funds need repo markets to meet sudden cash requirements.

“Collateral and liquidity management for non-banks at year end has become so difficult that this year we heard of funds starting to prepare their positions from the end of August,” Hill said.