Bond Dealers Tell U.K. Debt Office Their Job Is More Onerous

  • GEMMS, investors raised concerns at consultion with DMO
  • Debt office saw lowest auction demand since 2009 this month

Tighter regulations are making it increasingly difficult to sell U.K. government bonds. That’s the message from gilt market makers and investors.

The environment is becoming more challenging as new rules increase costs and make banks less willing to risk their own capital, according to the minutes of a meeting between market makers, investors and officials of the Debt Management Office and Treasury.

Investors at the Tuesday gathering said the burden of regulation risks cutting liquidity and pushing up transaction costs -- particularly in the market for repurchases, or repos. They also raised concerns about the level of investor participation at auctions, the minutes published Wednesday show.

“There is no question that liquidity is lower in gilts,” said Richard Kelly, head of global strategy at Toronto-Dominion Bank in London, a gilt primary dealer. “The same can be said about other fixed-income products for that matter.”

The warnings come days after the latest sign of weakness in U.K. sovereign debt sales. A Jan. 20 auction attracted the lowest demand in nearly seven years, leaving investors and officials braced for a possible uncovered sale, and the DMO last year saw its first resignation of a primary dealer since 2009.

“A number of regulatory initiatives had combined to make market making more difficult as the banks have become increasingly wary about committing balance sheets due to rising capital cost,” market makers said, according to the DMO minutes. “It was also noted that banks are reassessing their business models accordingly.”

Credit Suisse Group AG resigned in October from its role as a gilt-edged market maker, or GEMM, for both conventional and index-linked gilts. While 20 gilt-market primary dealers remain, many of the world’s biggest banks are shrinking their bond-trading activities to comply with regulations such as higher capital requirements imposed following the financial crisis. That may mean prices become more volatile for investors.

It’s not only the U.K. coming under pressure. An auction of German 30-year bunds Wednesday failed to reach its sale goal.

Government-bond dealers have told the Bank for International Settlements that new regulations are set to push up costs of capital further. A poll of 40 banks in August and September showed respondents expected costs to rise as they move to so-called Basel III rules, according to a Jan. 21 report.

U.K. investor concerns were echoed by the International Monetary Fund Wednesday. Risk-insensitive regulation is making the repo market unprofitable and the pursuit of financial stability “can go too far,” senior economist Andreas Jobst told a conference in Luxembourg.

“The economics of the market-making model has come under pressure from many sides,” said Christoph Rieger, head of fixed-income research at Commerzbank AG in Frankfurt, the biggest primary dealer of German bunds. “Regulations are a key aspect.”

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