ECB Makes QE Bonds Available for Lending to Ease Liquidity Woes

ECB: Early Recovery Phase, High Uncertainty

The European Central Bank began a bond-lending program to help unclog markets snarled up by its own debt-purchase plans introduced last month to boost growth and stave off deflation.

The move is important because it reduces the risk for traders that the region’s bond market becomes dysfunctional after the cost of borrowing securities in the repurchase market climbed due to a shortage of collateral, threatening to reduce liquidity. Bonds purchased under the ECB’s quantitative-easing program will be made available for lending from Thursday, the Frankfurt-based central bank said on its website.

“The aim of securities lending is to support bond and repo-market liquidity without unduly curtailing normal repo-market activity,” the ECB said in its statement. “The Eurosystem is primarily targeting market participants with market-making obligations.”

Repurchase agreements, or repos, are transactions used for short-term funding and typically involve the exchange of government debt for cash and the subsequent repurchase of the same or a similar security. It’s considered a lifeline for the fixed-income market because banks use it to help finance investments in other assets, including government debt, corporate bonds and mortgage-backed securities.

The ECB’s bond purchases have taken away some of those bonds which would have otherwise been available as collateral, making it more expensive to borrow in the repo market.

‘Collateral Squeeze’

“At the margin, this will be good for repos,” said Subhrajit Banerjee, a fixed-income strategist at HSBC Holdings Plc. in London. “Take one-year German general-collateral rate, for example. It has gone to minus 30 basis points, much lower than the deposit rate. This is an indication that down the line, there will be a huge collateral squeeze, which is what is getting priced in.”

A basis point is 0.01 percentage point. The ECB lowered its deposit rate to a record minus 0.20 percent in September. ECB President Mario Draghi said March 5 the central bank will not purchase securities that yield less than its deposit rate.

The ECB plans to pump 1.1 trillion euros ($1.2 trillion) into the region’s economy through September 2016. It started the bond-buying program on March 9 and set out to acquire 60 billion euros per month of government and private securities due between a minimum of two years and a maximum 30 years and 364 days.

Securities issued by supranational institutions and purchased under the public-sector purchase program by Eurosystem central banks will be made available for securities lending under the coordination of Banque de France and Banco de Espana, the ECB said.

Fixed Fee

The lending arrangements are designed to allow eligible counterparties, any time, to borrow securities at a fixed fee of 40 basis points, according to the ECB.

The fee is the difference between the repo and reverse repo rates. The term is a fixed maturity of one week. There is the possibility to roll over the transaction on a week-by-week basis for up to three times with the fee increasing by 10 basis points at each time, the ECB said. A haircut, or discount rate, of 4 percent applies to the securities provided as collateral in the reverse-repo transaction.

In principle, the arrangements are aimed at primary dealers of euro-area sovereign bonds and at other institutions with market-making commitments, provided that they fulfill all the legal requirements for the given securities lending activities. This involves, in particular, the signing of the relevant contractual documentation with the securities lending agent, Deutsche Bank AG, subject to the approval by the ECB.

Subject to availability, an individual counterparty may borrow up to 2.5 percent of the amount outstanding of a single issue with a maximum of 200 million euros for any such issue. Transactions should be split into tickets with a maximum nominal size of up to 50 million euros, the ECB said.

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