Credit Suisse Missing From Market-Making Is Bond-Buyer Omen

  • Pioneer Investments sees more banks withdrawing from service
  • Fewer counterparties means more gyrations in debt prices

Credit Suisse Group AG’s decision to stop making a market in government bonds across Europe may be the tremor that presages an earthquake for investors.

One week after the Swiss bank’s surprise withdrawal, as part of a slimmed-down markets strategy, money managers such as Pioneer Investments have grown concerned others might follow. The main cause: tighter regulations raised the cost of wholesaling debt.

“This could be the beginning of a wider trend,” said Gianluca Minieri, head of trading at Pioneer in Dublin, which oversees $242 billion. “Banks stay in a business only if it’s profitable, but the regulations expected in coming years are not envisaged to loosen capital requirements for banks. It could be the opposite.”

With many banks reporting declines in fixed-income trading, there’s a stunted capability to hold bonds and to make a market -- providing quotes to buyers as well as sellers. Withdrawals from market-making and primary dealing, or buying directly from sovereigns, may clog bond markets when reduced liquidity already makes trading tougher for investors.

As for the banks, long gone are the days when booming trading revenue led earnings presentations. Instead, many are retrenching as regulations on capital and transparency, imposed after the last financial crisis, restrict risk-taking.

Liquidity may shrink further under proposed rules that require banks to set aside even more capital to hold government debt, Vanessa Le Lesle, head of regulatory affairs in the Asia-Pacific region for JPMorgan Chase & Co., said on Thursday at a conference in Tokyo.

Inventories Stagnate

The size of government-bond inventories among German banks, for example, stagnated from the end of 2012 through March this year at about 250 billion euros ($274 billion), International Monetary Fund data show. During the same period, the market value of euro-area government debt swelled about 25 percent to 5.9 trillion euros, as tracked in the Bloomberg Eurozone Sovereign Bond Index.

The size of open-ended mutual funds that invest primarily in euro-denominated bonds has grown 17 percent since the end of 2010 to $655 billion last month, according to data compiled by Morningstar Inc.

Mutual funds tend to take shorter-term positions than pension funds and insurers, meaning the market is increasingly likely to move sharply after unexpected news. A diminishing number of counterparties during these periods would increase the risk of market gyrations.

Mutual Funds

“Mutual funds are now a much bigger proportion of the market than they were in the past, and they tend to react in the same way to major newsflows, with the same short-term performance concerns,” said Mark Nash, a money manager at Invesco Asset Management in London, which oversees about $768 million. “Shrunken balance-sheet capacity of banks is a problem because they serve to distribute risk.”

Credit Suisse, which operated as a primary dealer in seven European Union countries, said the focus of its so-called macro business will now be on foreign exchange. It will continue to make a market in U.S. Treasuries.

Primary dealers are firms obliged to bid at government bond sales to ensure smooth placement of sovereign debt. They have to purchase a certain amount of the debt issued each year and take the risk they may be unable to sell the securities afterward at a profit.

In return, primary dealers see benefits for this because, in most cases, they resell the securities to investors. Some central banks and pension funds will only do business with such financial institutions.

Barclays Plc, HSBC Holdings Plc and Citigroup Inc. are the top three primary dealers by numbers of European markets covered, according to data from the Association for Financial Markets in Europe. Spokesmen for the three banks declined to comment.

Capital Requirements

Stricter international bank-capital regulations have meant banks have less capacity to back their market-making business, where part of the role involves warehousing risk. The result is that prices can be more volatile for money managers and private investors.

Danske Bank Chief Executive Officer Thomas Borgen said Thursday that Denmark’s biggest bank had shrunk its fixed income, commodities and currency portfolio so it’s not a drag on financial targets.

“In the past, when you had someone wishing to sell or buy a bond, you always had someone on the other side, a market maker,” said Paolo Bernardelli, head of the bonds and foreign exchange team in Milan that oversees about $55 billion at Eurizon Capital SGR SpA.“These days market-making is more a brokerage activity. They just buy from you and want to immediately sell it to someone else. So, movements are much bigger.”

Not everyone sees the future as Credit Suisse does.

Deutsche Bank

Deutsche Bank AG said on Thursday that revenue from trading debt and currencies, the investment bank unit’s biggest component, rose 20 percent in the third quarter, and that fixed income is a core business. While it’s published strategy revamp calls for exiting market making of uncleared credit default swaps, government bonds weren’t mentioned. A bank spokesman in London declined to comment.

Germany’s biggest bank has remained committed to its FICC business even as European peers including UBS Group AG, Royal Bank of Scotland Group Plc and Barclays have more dramatically retrenched, according to Bloomberg Intelligence analysts Alison Williams and Dan Erichson.

This probably means only the biggest banks with the strongest balance sheets and significant market share will be able to compete profitably in the area. For Pioneer’s Minieri, that is not necessarily a positive trend.

“This will concentrate the power in the hands of fewer investment banks,” Minieri said. “It will certainly make the market less resilient to external shocks and turmoil.”

(An earlier version of this story corrected the spelling of Paolo Bernardelli’s name.)

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