When the European Central Bank announced its public sector purchase programme in January, the intention was always to lend out the securities it bought, easing technical squeezes on certain bonds, smoothing government curves and preventing trade fails. Lessons had been learned from the baby steps taken by the Federal Reserve and the Bank of England, back in the heady days when QE was a new monetary policy instrument.
So the announcement, on April 2, of the arrangements for lending out the securities did not shock the market.
But it should have. Unlike every other monetary policy tool used by the eurosystem, the securities lending programme allowed every national central bank to set its own rules, and this has not been flattering to the periphery.
Since the securities lending has to be “cash-neutral” — to avoid soaking up the extra liquidity created by the purchase programme — counterparties must present collateral to borrow collateral.
This has allowed Europe’s central banks to turn their noses up at government securities from other member states. Most of core Europe will not accept Italian or Spanish debt as collateral, according to a senior repo trader at a leading primary dealer bank.
Belgium appears to be the de facto floor for core Europe, though you will be able to swap Bonos for different Bonos at the Banco de España.
Other than the ECB itself, most of the national central banks have declined to specify their arrangements in public, saying only that collateral will be accepted subject to their risk management framework or according to existing bilateral documentation.
Some major central banks — notably the Bundesbank and the Banca d’Italia, custodians of the largest government debt markets in Europe — have not specified any borrowing arrangements. The Bundesbank has agreed to feed the securities it purchases into Clearstream’s automated settlement system, where they can be used to cure potential trade fails, but it has not set out any standing arrangements.
In practice, this fragmentation will not make a huge difference. The arrangements are supposed to be backstops to cover off-trade failures, or for emergency use — the prices are prohibitive for use as a trading strategy. Even where particular lines are trading very “special” — far through general collateral repo rates — the facilities are too expensive to work as an arbitrage.
Barclays research said: “This should ease richening pressure on some bonds, but due to the punitive rates and borrowing limits, it might be not be sufficient to prevent some dislocations on the government bonds curves.”
The diversity of repo arrangements probably reflects practical weaknesses — central banks which have suddenly been asked to do a lot more have not built up their operational arrangements to cope, and the ECB was in a hurry — but it is a potent symbol of distrust.
National central banks from the core do have plenty of exposure to peripheral governments, but they did not want it: they had to be forced. Statistics are hard to come by, but since early last year, when the “repatriation” requirement was removed, individual banks have had to accept eurosystem government debt as collateral for ordinary and long-term repo operations, with a set of conditions and costs set by the ECB.
The central banks of the eurosystem are the ultimate government insiders, and have supposedly formed the bulwark against eurozone distress since at least 2012. They are lending securities, against collateral, for one week only (the Banque de France will go out to a month), with a haircut as well. And in case of losses, these institutions can print euros.
What can be so worrying to the central banks of core Europe that they will not accept Spanish and Italian debt, even for a week at a time, unless they are forced to? Time for a show of real European unity from the institutions supposed to stand behind it.