CHAPTER 6
Issuance and Trading in Government Securities
The central government's primary dealers in government bonds are 10 regional and international banks. A primary dealer system with 8 partici pants will be established in connection with the reopening of the T-bill programme in February 2010.
In response to interest from market participants and lower liquidity in the secondary markets, Government Debt Management held two auctions in June. Against the background of positive experience from the first auc tions, issuance of government securities took place at regular auctions com bined with tap sales as from September 2009.
From the beginning of 2010, Government Debt Management has im ple mented new market making requirements based on the average bid-ask spread for all primary dealers. Hence, the market-making requirements are automatically adjusted to changing market conditions.
Primary Dealer System for Danish Government Securities 6.1
Danish government bonds are issued to and bought back from banks that have entered into primary dealer contracts with the central government. Primary dealer contracts are concluded with banks that intend to enter into long-term cooperation to trade and resell Danish government bonds to a broad range of investors.
Banks that have concluded primary dealer contracts can act as counter parties in the central government's issuance and buy-back transactions. The key obligation of the primary dealers is to ensure efficient market making, i.e. they must quote current bid and ask prices within the frame work set out by Government Debt Management in agreement with the primary dealer group, cf. Box 6.1.
| Primary dealer contracts | Box 6.1 |
Government Debt Management has concluded primary dealer contracts for government bonds and T-bills, respectively. The rights and obligations of primary dealers are speci fied in the primary dealer contracts, which can be found at www.governmentdebt.dk. Basically, the primary dealer contracts for Danish government securities contain the same elements as equivalent contracts in other EU member states.
The principal obligations of primary dealers are:
Primary dealers in T-bills must quote prices within predefined spreads for all T-bills with a remaining term to maturity of more than 1 month. |
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Ongoing price quotation on electronic trading platforms enable the market participants to monitor market developments and conduct trans actions at prices and volumes known in advance. This pre-trade infor ma tion fosters transparency and supports efficient price formation in the mar ket for government securities. It increases investor interest in gov ern ment securities and provides the basis for reduction of the central gov ernment's financing costs.
Efficient price discovery in government securities supports tradability else where in the financial market. On the basis of the prices for government securities, it is possible to estimate a government yield curve that can be used for pricing other types of securities or financial instruments.
Primary dealer systems for Danish government securities
Government Debt Management has concluded primary dealer contracts in Danish government bonds with 10 banks, cf. Table 6.1.1. BNP Paribas went from market maker to primary dealer in the autumn of 2009. In addition, Spar Nord Bank became a primary dealer in 2010, while Fionia Bank withdrew from the system at the turn of the year.
| Primary dealers and market takers, 2010 | Table 6.1.1 |
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| Primary dealers in government bonds | Primary dealers in T-bills | Market takers in government securities |
| Barclays Bank | Arbejdernes Landsbank | Bank of America Merrill Lynch |
| BNP Paribas | Danske Bank | Citigroup |
| Danske Bank | JP Morgan | Commerzbank |
| JP Morgan | Jyske Bank | Deutsche Bank |
| Morgan Stanley | Nordea | DZ Bank |
| Nordea | Nykredit Bank | Nomura |
| Nykredit Bank | SEB | Royal Bank of Scotland |
| SEB | Sydbank | |
| Spar Nord Bank | ||
| Sydbank | ||
| Note: A market taker can trade at prices quoted by the primary dealers, but cannot quote prices. Banks, who are primary dealers in either government bonds or T-bills, can be a market taker in the government security segment, where they do not act as a primary dealer. | ||
A primary dealer system for T-bills will be established in 2010. At the start of the year, 8 banks were comprised by the new system, which will take effect in connection with the reopening of the T-bill programme in February.
Besides the primary dealers, 7 banks participate in the market for gov ernment securities as market takers. A market taker can trade at prices quoted by primary dealers, but cannot itself quote prices.
Most euro area member states have established primary dealer contracts in government securities. As a result of the single currency and financial integration, most of the primary dealers are international banks.
In an international context, the Danish market for government se cur ities is small due to the low debt and the size of the economy. Compared with most other European countries, the Danish primary dealer group is characterised by a relatively large share of regional banks specialising in the Danish market, cf. Chart 6.1.1.
| Number of Primary dealers in bonds in selected countries | Chart 6.1.1 |
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Note: In Germany primary dealer contracts are not applied. The account for Germany covers market participants that can place bids at the Bunds auctions. Source: Websites of the respective government debt management offices and the European Primary Dealers Handbook, January 2010. |
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Banks have easy access to the Danish market for government securities
A broad group of primary dealers enhances interest in Danish government securities and supports competition in connection with issuance and buy-backs by the central government. Government Debt Management there fore focuses on keeping access to the market-maker system as simple as possible.
Market participants can become primary dealers if they intend to enter into long-term cooperation and meet the primary dealer contract require ments. Government Debt Management finds it particularly important that the market-making activities of the primary dealers foster price trans par ency in the market. There are no minimum requirements for participation in auctions or requirements for detailed reporting on turnover. Gov ern ment Debt Management has not rejected any banks that have expressed an interest in becoming primary dealers.
Market Making Platforms in 2010 6.2
Interdealer price-quoting system
Every year, the primary dealers prepare a report on the infrastructure of the Danish market for government securities. This report forms the basis for an evaluation of the structure of the market for government secur ities, including the chosen platforms for ongoing market making. Against this background, the primary dealers decide on the market-making plat forms in the coming year. The 2009 primary dealer report contains the following conclusions1:
- The expected costs of spreading market making on more platforms in 2010 will exceed any benefits
- There is a risk that some primary dealers will leave the system if market making is spread on more platforms
- The competition between platforms will intensify due to the annual evaluation and because market-making platforms are selected for only one year at a time
- The primary dealers were satisfied with the market making on MTS Denmark in 2009.
Against this background, the primary dealers chose MTS Denmark as their market-making platform in 2010. Moreover, no other electronic platforms had expressed a wish to become part of the market maker system for primary dealers.
Price-quoting system aimed at the retail market
Government Debt Management has a price-quoting system on NASDAQ OMX with five banks (Danske Bank, Nordea, Nykredit Bank, Spar Nord Bank and Sydbank). The participants commit to quoting bid and ask prices within predefined spreads and for minimum amounts for 90 per cent of the time between 9:00 a.m. and 4:30 p.m.
Through the price-quoting system, investors have ongoing access to pre-trade information for Danish government bonds. Members of the bond sub-segment on NASDAQ OMX can trade directly with the price quoters. In addition, investors have access to submitting orders in the trading sy tem via their banks. This enables retail investors to trade directly in a transparent market.
Market Making in 2009 6.3
Government Debt Management eased the market-making requirements in connection with the financial crisis. In step with the stabilisation of the financial markets, the market-making requirements have gradually been tightened with a view to improving liquidity and price transparency in the market for government securities. At the end of the year, the maximum bid-ask spread for 2-, 5- and 10-year benchmark securities had been re duced to 15 ticks, cf. Chart 6.3.1. The development in the spread between the best bid and ask prices in the Danish market was similar to that in other European markets for government securities.
| Bid-ask spreads for the 2-, 5- and 10-year benchmark securities | Chart 6.3.1 |
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| Note: Bid-ask spreads are stated as averages of the best bid and ask prices. Normal market-making conditions are equivalent to maximum spreads of 3, 5 and 7 ticks in the 2-, 5- and 10-year benchmark bonds, respectively. Market making on best effort basis implies that the primary dealers quote prices and sizes to the best of their ability. Source: MTSDenmark. |
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Besides adjustment of the framework for bid-ask spreads, the depth re quire ments were raised to the pre-crisis level. The market depth reflects the volume that can be traded at the best price, and thereby the volume of Danish government securities that can be traded without affecting the price.
Despite the normalisation of the requirements, the actual market depth in the benchmark securities at end-2009 was approximately half of the level before the collapse of Lehman Brothers, when the bids submitted were considerably above the minimum of DKK 80, 40 and 50 million in the 2-, 5- and 10-year segments, respectively, cf. Chart 6.3.2.
| Depths in 2-, 5- and 10-year benchmark securities | Chart 6.3.2 |
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| Note: The depth is calculated as the daily average of the volume entered at the best bid and ask prices. Normal market-making conditions are equivalent to a minimum size of DKK 80, 40 and 50 million in the 2-, 5- and 10-year benchmark bonds, respectively. Market making on best effort basis imply that the primary dealers quote prices and sizes to the best of their ability. Source:MTSDenmark. |
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New market-making framework in 2010
The gradual tightening of the market-making requirements in 2009 has had a limited impact on liquidity in most European markets for govern ment securities. Several countries have adjusted their market-making frame works in order to improve liquidity.
In 2010, new market-making requirements were introduced in the Danish market for government bonds, based on experience from else where in Europe, cf. Chapter 12. The market-making requirements are no longer fixed, but depend on the average bid-ask spread for all primary dealers. Hence, the market-making obligations are adjusted to changes in market conditions on an ongoing basis. The new set-up supports price quotation in both benchmark bonds and other government securities.
Turnover in Danish Government Securities 6.4
Turnover in the European markets for government bonds was low in 2009. Since the banks sought to reduce the risk on their balance sheets, they mainly traded government bonds where an underlying investor in terest existed. Moreover, the lower price transparency contributed to shift ing part of the turnover from the electronic trading platforms to the OTC market.
The average daily turnover on MTS Denmark, less government issuance on tap, was approximately DKK 200 million in 2009, corresponding to one third of the turnover in 2008, cf. Chart 6.4.1. Turnover increased in step with the improvement of the financial markets and the narrowing of the bid-ask spreads. Turnover on the other electronic platforms has broadly mirrored turnover on MTS Denmark.
| Average daily Turnover in Danish government securities | Chart 6.4.1 |
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| Note: Turnover on MTS Denmark does not include issuance on tap. Other electronic trading platforms are BondVision, NASDAQ OMX and TradeWeb. Source: Reports from the respective trading platforms. |
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Primary dealers have borrowed fewer securities from the central government and SPF
The central government's primary dealers have access to the securities lend ing facilities of the central government and the Social Pension Fund, SPF. The government's lending facility comprises on-the-run issues and bench mark securities. Other government securities with a remaining term to maturity of more than one month are available via the SPF lending facility.
The securities lending facilities support an efficient market for trading in Danish government securities as primary dealers can borrow government securities in the event of a shortfall in the market. Lending of securities is collateralised by other Danish government securities. Securities lending runs for up to 5 banking days. In 2009 the average maturity was 1.9 days. The terms and conditions for use of the facilities are presented in the Ap pendix Terms for the Securities Lending Facilities of the Central Govern ment and the Social Pension Fund.
The demand for securities lending declined in 2009, reflecting lower turnover in the secondary market. In 2009, total securities lending de creased by 45 per cent compared with the preceding year, cf. Table 6.4.1.
| Securities lending, 2007-09 | Table 6.4.1 | ||
| DKK billion | 2007 |
2008 |
2009 |
| Central government | 34.2 |
25.0 |
53.2 |
| SPF | 89.8 |
143.5 |
38.4 |
| Securities lending, total | 124.0 |
168.5 |
91.6 |
Issuance of Government Bonds 6.5
The start of 2009 saw significantly deteriorated conditions for gov ernment issuers. The higher government-borrowing requirement and increased issuance of government-guaranteed bonds intensified compe ti tion for investors among high-rated issuers. At the same time the stronger volatility in the financial markets at the beginning of the year caused demand to fluctuate. Finally, the banks' need to reduce their own risk diminished their capacity to trade and resell bonds, entailing a decline in liquidity and price transparency in the markets for government securities.
Hence, a number of government debt management offices embarked on more flexible issuance strategies. As a result, auction calendars with fixed dates of issue were to some extent replaced by more frequent auctions announced at shorter notice. In several cases, the interval for the amount offered at the auctions was extended in order to reduce the risk of unsuccessful auctions with sales below the announced volume.
Auctions were still the primary issuance channel for government debt man agement offices, but to a higher degree than previously they were sup plemented with other channels, including syndicated loans and tap sales.
Introduction of auctions in Denmark
As in other countries, liquidity was lower than previously in the secondary market in Denmark. In response to interest from primary dealers, Govern ment Debt Management introduced issuance via auctions in June. This enabled investors to buy a larger amount of government bonds directly from the central government by bidding at the auction via a primary dealer. At the same time, it enabled the banks to steer clear of the risk linked to holding bonds on their balance sheets.
Demand was substantial at the auctions, and Government Debt Man agement sold the maximum amount of government securities announced. The primary dealers reported that the auctions attracted several major investors to the Danish market for government securities. The auctions encouraged banks to intensify their marketing of Danish government securities, thereby boosting investor interest in Danish government bonds. Moreover, the auctions provided an updated price picture of the on-the-run issues. The positive experience prompted Government Debt Manage ment to introduce regular auctions as from September 2009.
Auctions in Danish government bonds
Auctions are announced well in advance in order to create awareness of and increase interest in the issuance. Prior to the auction, Government Debt Management announces the maximum issuance volume. Selling the maximum announced volume at each auction is not an objective. The allotted volume and price are published shortly after the deadline for submission of bids, cf. Box 6.2.
| auction method for danish government bonds | Box 6.2 |
The central government's auctions take place via MTS Denmark's TradeImpact auction system with the primary dealers of government bonds as counterparties. Investors can submit bids for the auctions via the primary dealers. Auction stages are: |
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| 1 Danmarks Nationalbank's system for transmission of information to connected news agencies. | |
A total of 10 auctions (excluding opening auctions) were held for the key on-the-run issues in the 2-, 5- and 10-year maturity segments. All primary dealers received allotment over the 10 auctions. Auction issuance was con cen trated on three primary dealers that received approximately 75 per cent of the allotted volume. The concentration was higher for issuance on tap, as two primary dealers received more than 75 per cent of the allotted volume, cf. Chart 6.5.1.
| Issuance by auctions and on tap-sales by primary dealers, 2009 |
Chart 6.5.1 |
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| Note: Exclusive opening auctions. Primary dealers have been made anonymous. Source: MTS Denmark. |
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Issuance methods in 2010
Against the background of the positive experience, Government Debt Man agement will continue to issue government bonds via regular auc tions. Issuance via auctions will be supplemented with tap sales. Issuance on tap provides a regular supply of government securities in the on-the-run issues, making it easier for the banks to accommodate demand from investors on non-auction days. This supports liquidity in the secondary market.
[1] The key elements and conclusions are published in Infrastructure in Danish government securities market in 2010, www.governmentdebt.dk.
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