Distribution via syndication rather than auction
In addition to the prospect of earning fees, it is the rarity of syndicating pure UK government risk that makes this a highly prestigious mandate to win. The last syndicated UK government deal came through the auspices of the Debt Management Office – the £1.25 billion 50-year index-linked sold in September 2005 via Barclays, Morgan Stanley, RBS and UBS. Until that point the DMO had always preferred auctions, but after it suffered a mixed result on an ultra-long-dated fixed-rate deal sold earlier that year, it turned to syndication in an attempt to get a better result.
The last time a similar deal was done was way back in June 2003. The Bank of England sold $3 billion of five-year paper on behalf of the UK government, which wanted to fund foreign currency reserves, via Deutsche Bank, Citigroup, Goldman Sachs and Morgan Stanley. The fact that no UK banks managed to get on the top line was highly notable. The Bank of England argued at the time that it chose its lead managers purely on the quality of the advice given. It managed to obtain the funding for the Treasury cheaper than through the issuance of gilts.
This time around the bank is raising cash for its own foreign currency reserves. It has held its own reserves since 1997 when it gained independent control of monetary policy. Because there was the theoretical possibility of the UK entering the single European currency, the Bank of England has hitherto raised euros to fund the reserves via auction. But with that possibility now over in the medium term and, consequently, the likelihood of going into Target 2 (the payments system that allows the European Central Bank to implement its single monetary policy), the Bank of England’s old euro note programme is now over.
Euros not cost effective
The euro auction was not very cost effective from a funding perspective. The paper priced some five to 10 basis points cheaper than where the UK government credit spread should be versus sovereign peers. The bank has three euro deals outstanding, worth €7 billion in total. There are two €2 billion bonds that are due in 2007 and 2008, and a €3 billion bond due January 27 2009 is the last to redeem.
The Bank of England’s move comes at an interesting time for Europe’s sovereign debt managers. The European Commission has finally embarked on a fact-finding mission to look at possible restrictive practices pertaining to sovereign debt. Dealers have privately complained that some of the conditions that are placed on them by the debt managers – especially relating to providing secondary-market liquidity on electronic trading platforms and performance at auctions – are extremely costly. These costs are only justified by winning the mandates to issue primary debt but they also distort the market’s operation.
Electronic platform providers have also complained that they are effectively shut out of a portion of the market because the debt managers use the MTS platform to measure banks’ provision of secondary-market liquidity.
Despite the fact that there are precious few syndicated bond mandates to be won, the UK’s gilt market, run by the Debt Management Office, is one of the few European sovereign debt markets where the dealers make decent profits.
Gilt-edged market makers (Gemms), as the UK primary dealers are called, are not forced to provide liquidity to investors, as many dealers are in the euro zone.
The dynamics for Gemms are unlikely to be changed by the Bank of England’s annual awarding of a bond mandate not least because the DMO has been independent from the central bank since 1997.