Bond-Market Gloom Rebuffed as Danske Seeks Primary-Dealer Roles

  • Danish bank studying more markets to enter as others exit
  • Margins compressed in business of reselling sovereign debt

As shrinking revenue causes banks to cut back on trading government bonds, one lender in Scandinavia is showing it’s not all doom and gloom.

Danske Bank A/S, backed by a Nordic pension-fund client base, last month won the right to become a primary dealer in Spain -- buying directly from the nation’s Treasury. This came just weeks after Credit Suisse Group AG decided to withdraw from that role in Spain and across Europe, saying it had better uses for its capital.

With historically low yields and higher capital requirements, banks are being forced to redraw their strategies to make the best use of cash. For some, that means re-examining their role as a primary dealer, in which they have usually promised to buy a portion of all new bond offerings. ING Groep NV, for example, dropped out of primary dealership in the Irishgovernment-debt market in December. A spokeswoman for the Dutch bank declined to explain its reasons.

“Despite years of adjustment, there is still more to come in terms of banks rationalizing the capital that they have tied up in fixed income,” said Christopher Wheeler, an analyst in London with Atlantic Equities LLP. “The problem with some big banks is that they have a lot more legacy assets on their balance sheet which they are trying to get rid of. Some smaller banks like Danske are well-capitalized and they don’t have a legacy issue.”

Danske, Denmark’s biggest lender, also considers the Netherlands attractive for becoming a primary dealer, with its deep client base, according to its head of fixed-income trading, Soeren Moerch.

“We choose markets where we have an ambition, and a good chance, to be a top-five player,” Moerch said in an interview. “It’s still a tough market, and you can’t be everything to everybody. If you are not among top-tier players, it’s not worth it.”

Primary dealers are securities firms that are obliged to bid at government bond sales to ensure smooth placement of sovereign debt. They have to purchase a certain amount issued each year and take the risk they may be unable to sell the securities afterward at a profit. In some European countries including Spain and Portugal, primary dealers are also required to actively quote bid and offer prices in the secondary market. 

In return, primary dealers traditionally saw benefits for this because some investors, such as central banks and pension funds, will only do business with such financial institutions.

Dodd-Frank, Basel III

Banks are shrinking their bond-trading activities to comply with regulations such as Dodd-Frank in the U.S. and Basel III, which were put into place to keep financial firms from taking the types of risks that led to the 2008 financial crisis. These restrictions have reduced their ability to build an inventory of securities that carry risk. 
 
Adding to the challenges are historically low yields, relatively low volatility and declining market liquidity that erode profit margin further, thanks to monetary-policy easing in most major economies.

The retrenchment has already led to job cuts in the industry, with Morgan Stanley eliminating 1,200 workers worldwide, including about 470 traders and salespeople in its fixed-income and commodities business. Credit Suisse, Barclays Plc and UBS Group AG have also pulled backed from some trading operations.

JPMorgan View

“In this market, you cannot have a long-term and successful franchise in a product unless you are a significant and consistent player,” said Carl Norrey, head of rates securities in Europe, Middle East, and Africa at JPMorgan Chase & Co. in London. “We always look through the cycle, and although we know the market is in a difficult period of that cycle at the moment, we haven’t pulled back or reduced our dedication to any of these clients.”

Dealers may be lured to Spain after its government bonds returned about 30 percent in the past three years, more than their German, U.S. or British counterparts during the period. The country’s reforms, economic recovery, yield premiums over core-market securities and the European Central Bank’s bond-buying program have attracted buyers. Spain’s debt has returned 0.1 percent in 2016, underperforming the eurozone average, which has earned 0.5 percent for investors.

Scandinavian investors were the fourth-biggest regional group of buyers of the 9 billion-euro ($9.8 billion) 10-year bond Spain’s Treasury sold last week. Moerch said Danske’s clients are interested in the Iberian nation.

“Nordic investors have bought around 10 percent of every Spanish bond syndication in the past three or four years,” Moerch said. “We have clients globally, but Nordic clients are our bread and butter. We go where they have interest.”

Spanish Market

Spain has 21 primary dealers and market makers. Its 2014 ranking, the latest report available, showed Citigroup Inc., Barclays Plc, Banco Bilbao Vizcaya Argentaria SA, CaixaBank SA and HSBC Holdings Plc as the most active for bonds. Moerch said Danske considers itself a top-tier player in Finland, Ireland and all three Nordic markets.

The decision by Credit Suisse, which will remain a primary dealer for U.S. Treasuries, coincided with the Zurich-based bank’s overhaul of its trading and advisory services, after fixed-income revenue service plunged.

Some fund managers including Pioneer Investment were concerned about a risk that other banks may follow Credit Suisse, leaving bond markets less efficient. While some banks may continue to pare their primary-dealer business by withdrawing from markets where they are a marginal operator, few are likely to take as drastic a move, according to George Kuznetsov, head of research and analytics at London-based data and analytics firm Coalition.

“There’s concern among some investors that other banks may follow, but I think a certain bank’s decision is unique,” Kuznetsov said. “There will continue to be further adjustments in the bond market due to a tougher environment. At the same time, anecdotal evidence we have suggests there are also pockets of new opportunities.”

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