Crisis Redefines Liquidity as Denmark Diversifies Debt Sales

Denmark’s takeaway from the global financial crisis is to tap as many different debt markets as possible in case one dries up, even if that erodes liquidity in individual series.

The debt office at the Copenhagen-based central bank saw its two-year bond yields turn negative last year after investors fleeing Europe’s debt turmoil sought refuge in AAA Denmark. Though a surge in volatility last month sent that spread to its widest since February 2010, investors are now coming back. Ove Sten Jensen, who heads the debt office, says the trick is having a broad enough palette to ensure there’s always one class of bonds investor ready to buy, no matter how panicked markets are.

“We have more products now compared with a few years ago and that means the individual series may not be as large,” he said in an interview. “It’s not just about building up a very large 10-year or 2-year series. It’s also about having different types of products. That’s also a way of creating liquidity.”

Adding to its portfolio has helped Denmark attract investors from the U.S., China and South America. That’s helped keep Denmark’s 10-year yield below the U.S.’s. The Scandinavian nation pays about 80 basis points less to borrow over that maturity than the government of the world’s largest economy.

Extra Revenue

Denmark last year introduced its first inflation-linked bond to tap interest from pension funds seeking protection against price increases that may erode savings. The debt office also reintroduced a Treasury bill program in 2010 that was dropped two years earlier. In April, it sold debt in U.S. dollars.

Denmark is set to receive extra revenue of about 40 billion kroner ($7 billion) over the next two years from capital pension taxes, which the government has said will be used to repay debt.

The debt office has no plans to change its issuance pattern as Denmark’s public finances improve, Jensen said.

The debt office will keep a “relatively stable year-on-year issuance,” Jensen said. “We have communicated very clearly that we won’t submit to a stop-go policy where we suddenly change our issuance.”

Yet definitions of liquidity vary. Some of Denmark’s biggest investors say the debt office’s decision to offer more series is damaging the depth of existing issues and eroding liquidity.

Buy Side

“It may be that that the debt office has had an easy time selling its papers in recent years due to international circumstances,” Poul Kobberup, who oversees about 100 billion kroner ($17 billion) in Danish mortgage and government bonds as head of fixed income investments at PFA Asset Management, said in an interview. “But that may not be the case going forward, so liquidity management is even more important.”

Kobberup wants the agency to “more aggressively” buy back illiquid bonds, including the 2 percent 2014 note and the 7 percent 2024 bond, freeing it to issue more in its benchmarks.

“Denmark is already starting to pay the price as we can see that the premium paid compared with other nations is getting bigger,” he said. “Investors really don’t like illiquid markets.”

The difference in yield between Danish and German 10-year bonds, which was negative through most of last year, reached 14 basis points at the end of last week. Denmark’s government bond market is about one 13th the size of Germany’s 1.1 trillion euro ($1.4 trillion) debt market.

‘Very Expensive’

The debt office isn’t planning to follow PFA’s advice because buying up Denmark’s illiquid series would be “very expensive,” Jensen said. “Our mandate is to manage the government debt as cost-efficient as possible,” he said.

The debt office has bought back a nominal 5.2 billion kroner in illiquid bonds this year at a market price of 6.4 billion kroner, according to its website. In 2013, it has issued bonds for 50.5 billion kroner, mostly in its 10-year benchmark, the 1.5 percent 2023 note.

Anders Svennesen, co-chief investment officer at ATP, Denmark’s biggest pension fund with about $140 billion in assets, said the debt office’s efforts to maintain liquidity are enough to meet its demand.

“Liquidity issues are something all bond markets are facing,” said Svennesen, who manages about 50 billion kroner of government bonds, mostly Danish. “The biggest threat to liquidity comes from regulatory developments. The banks have historically been large providers of liquidity for the bond markets. With regulation like Basel III, banks’ trading functions are being scaled down.”

Cash Buffer

The debt office has taken advantage of record-low yields to prefund about one year ahead. That means this year’s issuance will cover the government’s 2014 financing need.

Nordea Bank AB said in a June 25 note the debt office may consider suspending the T-bill program next year and instead sell bonds as the financing need shrinks and prefunding boosts state coffers.

“We have a cash buffer now, but’s it’s our stated intention to keep a buffer,” Jensen said.

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