Despite the eurozone covered bond market’s huge size, its liquidity is dwarfed by that of smaller sectors outside the currency bloc — effectively, the market is becoming impotent.
The European Central Bank’s love for covered bonds has almost smothered the market out of existence. Systematic buying over three purchase programmes and easy access to cheap repo funding has made it strategically irrelevant for accessing liquidity or market based funding.
A study in the European Covered Bond Council’s Fact Book shows secondary market turnover is higher in markets outside the eurozone, where bonds are ineligible for the purchase programme, than in where they are.
Turnover in the Norwegian, Australian and UK covered bond markets, which had a combined size of €300bn last year, equated to around 30% of their outstanding size — testifying to their “solid intrinsic liquidity”, said the Fact Book authors.
In contrast, turnover in the French, German, Spanish and Dutch markets, collectively more than three times the size of the former group, was half that, at around 15% of their outstanding size, which “clearly shows the trading activity gap”.
It’s not just that the ECB is hoovering up bonds in the secondary market, and never selling them again that’s destroying liquidity. It’s also swamping markets with cheap repo facilities that drastically cut supply and thereafter liquidity.
Covered bonds are the most utilised asset for repo purposes at the ECB, accounting for 34% of the €1.7tr of marketable assets used as collateral in the second quarter, based on Barclays analysis. This sets a new record and shows that the ECB’s Targeted Longer- Term Refinancing Operations have affected covered bonds more than any other sector.
The ECB has neutered the covered bond market.