Central Bank commences reverse auctions in MGS

Last Monday, the Central Bank of Malta officially announced the start of reverse auctions in Malta Government Stocks as part of the Quantitative Easing (QE) or the Public Sector Purchase Programme (PSPP) being conducted by the European Central Bank.

It is worth recalling that the QE programme started in March 2015.

This is a means of money printing through a process by which national central banks inject cash into an economy by buying government bonds from banks and other holders of such securities including retail investors.

Prior to the official announcement, the Central Bank of Malta convened a meeting for all market participants last Friday. The Deputy Governor of the Central Bank of Malta commenced the meeting by stating that the decision to conduct reverse auctions was taken due to the fact that the Central Bank of Malta is not meeting its monthly quota of purchases.

Statistics published on a monthly basis by the ECB show the purchases conducted by each national central bank across the Eurosystem. The statistics reveal that since the start of the QE programme in March 2015, a total value of €598 million of MGSs have been purchased by the ‘QE desk’ at the Central Bank of Malta. Some readers may be questioning the meaning of a ‘reverse auction’. It is a customary auction but the bidders in this case are sellers and not buyers. As such, in a reverse auction, potential sellers compete to undercut one another on price, such that the lowest bid is the winning bid.

Reverse auctions were initially conducted on a trial basis by only three central banks within the Eurosystem (France, the Netherlands and Lithuania) between October and December 2015. This system was also adopted by the US Federal Reserve in its own quantitative easing programme some years ago.

The reverse auctions in France, the Netherlands and Lithuania had different criteria but the experiences were all positive as the reverse auctions generated adequate participation and led to competitive pricing.

A reverse auction is a customary auction but the bidders in this case are sellers and not buyers. As such, in a reverse auction, potential sellers compete to undercut one another on price, such that the lowest bid is the winning bid

Based on these results, the Eurosystem concluded that reverse auctions may be a complementary method in less liquid markets and the ECB’s Governing Council endorsed a regular use of reverse auctions by some national central banks apart from the continuation of the customary regular purchases of public sector assets during the ordinary course of the QE programme. The Central Bank of Malta officials explained that the trials by the three central banks not only encouraged competitive pricing but also improved the transparency of the system adopted to date.

In fact, in the QE programme conducted in Malta since March 2015, the individual trades showing the volume and prices achieved by the individual sellers are not disclosed on a daily basis via the Central Bank or the Malta Stock Exchange website. As such, it was impossible to follow market movements and guide potential sellers on the best prices that may be achieved in particular securities.

On the other hand, under the reverse auction, the Central Bank will publish on a weekly basis the total amount offered by investors across all the various securities (i.e. an aggregate of all the offers received) and the total amount accepted (an aggregate of all the offers that have been accepted by the Bank). Moreover, for each MGS, the minimum price, the weighted average price and the maximum price paid per individual security will also be revealed. The reverse auction therefore provides a more transparent approach compared to the ‘bilateral’ purchases conducted so far.

The first reverse auction in Malta was held yesterday but by the time of going to print, the results had not yet been published. Reverse auctions in Malta will be conducted on a trial basis as a start and if they prove to be successful, reverse auctions will become the standard means by which the QE programme will be conducted in Malta.

The officials at the Central Bank explained that on a Monday afternoon, the various securities in which an auction will take place on the following Wednesday morning will be announced. Between four and six individual MGSs will form part of the weekly auction. Once the individual securities will be revealed on Monday afternoon, it will allow sufficient time for participants to prepare for the auction taking place between 10.30am and 11.30am on the Wednesday.

The Central Bank confirmed that within a maximum of one hour after the closure of the auction, the successful bids will be announced. These will then be passed in the normal manner in the over-the-counter (OTC) market and settlement will also take place on a T+2 basis, that is, two business days after the trading day.

In reverse auctions, the minimum size of a bid is of €100,000 nominal as opposed to the minimum participation of €50,000 nominal under the daily QE programme. Furthermore, multiple bids can be placed at various prices, provided that all bids are for a minimum of €100,000 nominal.

The auction will, in fact, be a multiple-price auction and, therefore, allocation will take place on a variable rate with discriminatory pricing (multi-price auction). As such, one particular MGS may be purchased at multiple prices.

An important development is that on a Wednesday, when reverse auctions are taking place in a specific set of MGSs, the daily QE programme will not take place.

At the end of last week’s presentation, the Central Bank of Malta indicated that a further €600 million of MGSs may be repurchased under the current QE programme running to March 2017, which is the current deadline of the QE programme across the Eurosystem.

However, this deadline may well be extended once again as the ECB continues to grapple with weak inflation statistics. Given the particular circumstances of the market in Malta with highly liquid financial institutions that do not need to dispose of their MGS holdings to expand their loan book and with many retail investors still adopting a ‘buy and hold’ strategy, the task of the Central Bank of Malta to achieve the ECB quota is a tough one and can only become harder to achieve as more time passes.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

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