Stop deceiving the market: book clarity must improve
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Covered Bonds

Stop deceiving the market: book clarity must improve

Demand for a deal can be accurately reflected only in the context of a specific spread. Anything other than that can mislead investors, so the ECB should demand better.

The European Market Abuse Regulation does not specifically say what joint lead managers are obliged to publish about the size and shape of an order book.

But that shouldn’t matter. It specifies a lot of things that shouldn’t be specified, and leaves untouched lots of practices that should be stopped.

The spirit and purpose, though, of this regulation starts with the idea that a truthful representation is given to all investors on a level playing field.

In a market where every last basis point counts, it has to be wrong to give investors the impression that the scale of interest in a deal is steadfast, no matter what the spread.

This is particularly pertinent today because the tide is beginning to turn in some asset classes. Deals are no longer a guaranteed succession of heavily subscribed slam-dunks.

In covered bonds, investors have started to push back on pricing. They are no longer the indiscriminate price takers that they were once forced to be by the central banks.

Not that you would necessarily know it from looking at published book updates.

All too often, the most flattering level of demand is the only one that gets published.

This approach is undoubtedly designed to encourage wavering investors, who will initially have set spread limits, to come over the finishing line and into the deal at the tightest possible spread — which is, after all, the job of the syndicate.

When initial price thoughts are translated to official guidance, the order book invariably hides the fact that some interest is limited to a specific spread.

Likewise, revised guidance levels may well hide the fact that an even larger portion of orders is outside the range.

ECB keeps volume the same

However, in markets such as covered bonds, as these orders fall out they are typically replaced by central bank demand, so the overall number may stay broadly the same.

Usually this change occurs towards the end of the bookbuilding process, with a sizeable ticket from the ECB making up for the lost demand.

That allows the order book volume to look constant, but the make-up can and usually does change considerably.

Arranging banks can be fairly certain that the central bank will be there to backstop any eligible covered bond by 40% — or in some cases by more than 50%.

The ECB would rather not be seen as setting the price for covered bonds. So, by waiting until the shape and size of private demand is almost clear, it tries to let the market set the price.

It is therefore misleading to set out the size of the order book without giving a clear indication of private sector price sensitivity within it. It matters to investors whether the rest of the book is central bank orders or their fellow private sector accounts.

The market abuse regulation says nothing about publishing order book sensitivity but this should not stop the ECB from demanding it. It is acting in a market heavily distorted by its actions, and it has a responsibility to do everything it can to maintain efficient market functioning.

With the ECB’s net asset purchases expected to fall to zero this year, its overarching presence will, by grades, diminish.

If it really does intend to nurture the market back in the most seamless way possible, it could start by siding with investors — by demanding to see where orders are limited and then mirroring them.


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