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March 2000

Only the liquid need apply


Bond Trading




Suddenly every large European bond issuer wants to be a part of EuroMTS, the euro government bond trading platform developed by MTS, the Italian exchange. It has attracted some 25% of European government bond trading volumes and now large European non-government borrowers are furiously lobbying it to admit their bonds on the system as well.
But rather than simply open the existing system to them, EuroMTS has set up a separate platform for credit products, to be called EurocreditMTS. "We decided that rather than simply incorporate non-government bonds into EuroMTS on an ad-hoc basis, it would be easier to set up a dedicated division," explains Robert Walton, manager at EuroMTS. "One immediate advantage of doing this is that it allows us to vary the eligibility criteria from those in force for the EuroMTS government system."
Last month EuroMTS published its eagerly-awaited eligibility criteria for EurocreditMTS. They seem tailor-made for Pfandbriefe: bonds allowed on the system have to be triple-A, collateralized with mortgages or public sector loans and denominated in euros. That will please some Pfandbrief issuers. "I think electronic trading will give more transparency to the Pfandbrief market and will increase its efficiency," says Rüdiger Luchmann, treasurer of Rheinische Hypothekenbank. "It's an important step."
But the key question is how many non-government bonds will be allowed onto the system. The answer, at least for now, is only a few very large bonds. In practice, only a handful of Pfandbriefe will meet the minimum size criteria: outstandings must be at least ?3 billion, with the further requirement that the issuer must have a total of ?10 billion of outstandings in that asset class. "If we set the limit at ?5 billion, there would only be one bond eligible at the moment," says Walton. "If we set a minimum of ?3 billion we think there could be about eight bonds eligible by the end of the year. If we set it at ?2 billion, there could soon be as many as 25 bonds eligible."
The ?3 billion minimum has been chosen as a way to ensure that all bonds traded on the system are already highly liquid. "We have to gauge how small an issue can be and still benefit from electronic trading," says Walton. "Our experience with government bonds is that you need no less than five market makers per bond, fewer than that and there is not enough liquidity provision on the system. We think that a minimum size of ?2 billion may introduce too many bonds to start of with, meaning that we don't ensure sufficient liquidity provision for each bond."
But the rules are not set in stone. "Markets are dynamic," says Walton. "We are simply looking for the best starting place. It remains possible that we could lower the minimum criteria in future and extend EurocreditMTS to other sorts of bonds." He mentions French obligations foncières, the French version of Pfandbrief as an obvious extension, although, as a relatively new product, no issue would come close to matching the size criteria at present.
"We are starting with Pfandbriefe and similar issues because they already have strong market-making support," says Walton. "They are a natural first step. Obvious extensions could include supranational and agency bonds."
But how much will EuroMTS add to the liquidity of already large and heavily traded bonds such as Allgemeine Hypothekenbank's ?5 billion issue? .
"The trading dynamics of the biggest global Pfandbriefe are already similar to those of second-tier European government bonds," says Tim Jennison, senior Pfandbrief trader at Morgan Stanley. "They appeal to an entirely different user base than the regular jumbo. Since the EuroMTS system is open only to market makers, it remains to be seen whether liquidity can be further enhanced. What EuroMTS could provide, however, is a great deal of extra prestige for those bonds listed on it. If the system works, and we must work hard to ensure that it does, then the EuroMTS-listed Pfandbriefe could begin to separate themselves from the rest to become a truly international class of bonds."
Luchmann at Rheinhyp thinks that pricing benefits could appear in time if the idea is successful. "At first there will be little difference between the spreads of those bonds traded on EuroMTS and those not," believes Luchmann at Rheinhyp. "But if investors like the greater transparency, we could see a spread difference of a few basis points appear."
But EuroMTS doesn't want to antagonize its members by opening the system to all-comers. Before they can be listed on EurocreditMTS, bonds will have to be vetted by a panel of market participants. EuroMTS has asked its shareholders to nominate a six-strong committee which will decide whether bonds are sufficiently tradeable in practice. It may consider various factors. "The committee may decide that issuers would need to inform us about their issuance timetable," says Walton. "The government bonds that are traded on EuroMTS tend to have transparent issuance programmes."






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