ECB Reverse Auctions to Add Competition in Extended QE Program

  • Reverse auctions may affect prices for dealers: MIT professor
  • New buying method `useful' in less-liquid markets, ECB says

Bond purchases under the European Central Bank’s quantitative-easing program in 2016 may surprise some investors who grew accustomed to trading on a strictly bilateral basis -- via a phone call, e-mail, or on private trading systems.

After buying more than 480 billion euros ($524 billion) since March in government and agency bonds where prices and targeted securities weren’t disclosed, the ECB will begin using more transparency in deals. Some of the 19 euro-area central banks that carry out QE now may use reverse auctions, where potential sellers compete to undercut one another on price, the Frankfurt-based institution said this week.

After the French, Dutch and Lithuanian central banks tested the method since October, determining it can produce “competitive pricing,” the ECB said reverse auctions may be used alongside traditional buying in “some specific market segments,” without describing them. Conscious of reduced trading levels, the ECB said the new purchase method was found to be “useful” in less-liquid market segments.

The ECB is taking a gradual approach to opening up its bond-buying plan to more competition. That’s in contrast to the Federal Reserve, whose multi-year QE program largely used reverse auctions, in which investors and the public typically were advised days in advance of which securities were targeted.

Profit Margin

“Because auctions tend to be more competitive, the auction prices should be better” for the central banks that buy, even as dealers may “lose some profit margin,” said Haoxiang Zhu, assistant professor of finance at the Massachusetts Institute of Technology.

At the same time, “since auctions are transparent about the timing of the purchases, the dealers may actually source the bonds more efficiently before delivering” them in sales, said Zhu, who studied reverse auctions at the Fed.

The ECB endorsed reverse auctions for some central banks, without specifying which ones, and only in the part of its QE program dedicated to government and agency bonds, according to a statement on its website on Dec. 22.

An official at the Bank of Spain said the nation’s central bank didn’t think it was necessary to use reverse auctions.

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