Société Générale is resigning as a Gilt-edged market maker for the UK Debt Management Office, effective this Friday. It joins dealers such as Deutsche Bank, which left Belgium’s list of primary dealers last year, and Commerzbank, which exited Italy’s list around the same time. Not to mention Credit Suisse, which said in October that it would relinquish all of its European primary dealerships.
The cause of such moves is clear — the increasing cost of capital from more stringent regulations and the dwindling returns in a competitive business that is as much about prestige as profit.
The effects are only just being seen, however. When the subject of the struggling primary dealership model was raised at the Association for Financial Markets in Europe’s 10th annual European Government Bond Conference in Brussels in November, attendees joked that such concerns had been raised for as long as the conference had been running.
There may well be less joking now that the likes of Deutsche Bank and SocGen have relinquished dealerships — and the jokes will be even less funny in a few years once the age of central bank easing ends.
Of course, with the Bank of Japan cutting rates last week, adding to more dovish stances by the European Central Bank and the US Federal Reserve, such a time seems a long way off.
But it will come.
Primary dealers play a crucial role in ensuring the liquidity of the government bond market, from market making to buying up supply in primary. Dwindling liquidity may not be too much of a problem when central banks are pumping in cash, but once the taps stop and that drains away, sovereign issuers may well be concerned about the lack of primary dealers available to keep them afloat in troubled times.
And those troubled times may come soon. Hung parliaments are becoming increasingly common in Europe — witness Spain and Portugal’s general elections in the last few months — while populist, extreme political parties are on the rise.
Breaking apart?
The outline of the market also hints at a more fragmented European capital market — a far cry from the hopes of ever closer union.
One only has to look at some of the moves in primary dealer rankings. In many countries, domestic players are rising to the top of their own sovereign’s primary dealer league tables. That a troubled bank such as Monte dei Paschi di Siena has finished top of Italy’s primary dealership ranking ahead of international behemoths such as JP Morgan for two years running is a case in point.
Meanwhile, the likes of Société Générale appear to have decided it is no longer worth being in UK government bonds — the same for Commerzbank in Italy’s.
To their credit, sovereign debt offices are aware of the problem.
At GlobalCapital’s Italian Treasury Roundtable in Rome in December, Maria Cannata, director general, public debt, Italian Ministry of Economy and Finance, said issuers were on the banks’ sides.
“The sub-committee on EU sovereign debt markets of the Economic and Financial Committee have become more active in speaking to authorities and regulators to tell them to be careful and ask if they’ve thought about the unintended consequences on liquidity of the new measures they are considering,” she said.
Whether or not regulators will be willing to amend rules to allow the primary dealership model to function properly remains to be seen.
But it may well be they will have no choice. If more banks exit dealerships and sovereign funding costs rise, political zeal for ever more stringent rules on banks could weaken.
While no one wants a return to the loose regulations of the early 2000s, the cost to banks of providing support to sovereign bonds is one area that rule makers have gone too far.
Luckily, as soon as politicians start to feel the strain on their Treasuries’ finances, they are likely to realise that too.