The main banks trading in the European government bond markets are looking closely at the mechanisms used to offer government bonds in the primary market.
Given the huge size of the Bund market, Germany's Bundesbank muddles through with a surprisingly primitive and unreliable system for accepting bids from banks. That system services both Bund issues and the central bank's weekly tender offers, known as repos or Wertpapierpensionsgeschäfte. Banks bidding for German government bonds have up to now used phone or fax to send their bids through to the Bundesbank's 16 regional branches - known as the Landeszentralbanken - which sends them in turn to the Bundesbank's headquarters. The bids are then passed on to the finance ministry in Bonn, where they are scrutinized and sent back to the Bundesbank. Having made the allocation, the Bundesbank then relays it back to the banks, via the Landeszentralbanken.
With so many links in the chain, all done by phone or fax, mistakes have been inevitable. Orders were sometimes "lost" en route, and errors remained undiscovered until it was too late to correct them. A new e-mail-based bidding system now being introduced at the Landeszentralbank (LZB) in Frankfurt was conceived primarily to minimize human error. If it works well, however, it may become a powerful asset for the Bund and may even be adopted as a standard throughout Europe.
Since March 18, banks in Frankfurt have used the automated bidding system to transmit their bids for the Bundesbank's weekly tender. Bids are transmitted by electronic link, replacing phone and fax. Electronic receipts are issued as soon as the bid is received. The electronic link is not only more reliable than the phone but also quicker, says Norbert Schmidt, head of capital markets at LZB in Frankfurt. The system was Schmidt's invention. While the Bundesbank's directorate is capable of deciding the allocation "at ten past" the close of bidding at 11am, Schmidt says, it takes time under the old system for LZB staff to check that all the usual bidders are there and even longer for the finance ministry to respond. Bund traders in Frankfurt say that it is still common to wait two hours or longer for a result. In the meantime, they often have to build hedges against their open exposure. Once a bid has been submitted, the bank must take the paper.
The Bundesbank counters that the traditional system is getting faster all the time, and claims that in recent offerings it has responded to bidders just 45 or 50 minutes after bids closed. But that is not quick enough, says Andreas Gautsch, head of fixed-income trading at Commerzbank. In order to avoid any hedging at all, he says the job needs to be done in less than half an hour.
It is too early to judge whether that will be possible. So far, the system is being used only in Frankfurt, which covers only about 30% of total bidding volumes in repos (70% in Bunds) and excludes banks based in other cities such as WestLB, Bayerische Vereinsbank and Bankgesellschaft Berlin. Those banks have to wait for their local Landeszentralbank to join the system before they can take part.
The Bundesbank predicts that before the end of the year all the banks in Germany will be able to transmit bids electronically; by then, the system will have been extended to Bund issues too.The real test will come if and when the Bundesbank tries to persuade other central banks and finance ministries to adopt the same system. Schmidt of the LZB in Frankfurt would like that to happen because he believes in the efficiency of his own invention. The Bundesbank is also enthusiastic because it believes an electronic bidding system will lessen the need for primary dealers. Laura Covill