Following the announcement by the European Central Bank on January 22 about its €60 billion per month quantitative easing (QE) programme starting in March 2015, many questioned how QE will be implemented in Malta.
Executives of the Central Bank of Malta entrusted with the QE programme held an information meeting last week to explain the procedures for its implementation or, as it is now referred to, the Public Sector Purchase Programme.
The Central Bank confirmed that it would be required to purchase around €36 million per month in Malta Government Stocks between March 2015 and September 2016. The Central Bank representatives highlighted that the ECB promised that it would continue to purchase €60 billion worth of assets across the eurozone until inflation shows signs of approaching the two per cent level – with no definite end-date announced.
Any national central bank across the eurozone is allowed to purchase sovereign bonds with a maturity profile ranging from two years to a maximum of 30 years. Naturally, since the longest-dated MGS matures in 2040, the Central Bank of Malta needs to limit any purchases to a maximum maturity of 25 years.
An important consideration for retail investors is that the QE programme will only be eligible for minimum quantities of €100,000 (nominal) per MGS and therefore investors holding amounts less than this in any particular security cannot take advantage of this programme. Another important fact is that the ECB (via national central banks) will only buy in the secondary market and therefore will not be competing with other investors for new issues on the primary market.
The ECB (via national central banks) will only buy in the secondary market and therefore they will not be competing with other investors
Retail investors holding less than €100,000 nominal in any MGS would need to continue trading their MGS on the regular secondary market and the Central Bank made it a point to highlight that this QE programme will not conflict with its market making function which will continue to be provided on a daily basis as we have been accustomed for many years.
In order to take advantage of the QE programme, a member of the Malta Stock Exchange (a broker) would need to negotiate with the QE desk at the Central Bank on behalf of their retail and institutional clients. Once a price is agreed, the trade will be conducted via the Over-The-Counter (OTC) market and not via the regular market where the large majority of trades take place nowadays.
Another change is that trading in the ‘QE window’ will close at 1.30pm on the OTC market rather than at 12.30pm on the regular market. There is also the possibility of negotiating deals until 2.30pm but the actual trade will then be passed on the following day.
Despite the change in the trading ‘venue’ and the timing, settlement of executed trades will still take place in the normal procedure on a T+2 basis, i.e. two business days after the trading day. The Central Bank will also be making use of its right to amend the indicative price list during the course of its trading session. Currently, market participants and investors are accustomed to viewing the website of the Central Bank at around 10.30am to obtain the indicative bid prices at which the Central Bank is willing to buy and the offer prices – in the few instances they have stock available for sale.
The Central Bank explained that any changes to the indicative prices would be published by 11.45am and could reflect some QE trades conducted earlier on in the day. As such, market participants and investors need to constantly keep abreast of price movements during the day.
The OTC trades in the ‘QE window’ will not be visible on the website of the MSE. Instead, the ECB will be publishing the aggregate purchases of securities across the eurozone on a weekly basis.
Ever since the announcement in late January, many international analysts questioned whether the ECB would manage to implement its bond-buying programme given that – in view of the relatively low level of risk of government paper – banks, pension funds and insurance companies opt to retain sovereign bonds in their portfolios in line with regulatory capital requirements. The question is more pertinent to Malta given the particular circumstances across the local financial system with most financial institutions already holding very high levels of liquidity and a large number of retail investors also struggling to find a suitable number of investment opportunities. This was exacerbated by the recent MGS issue which was insufficient to meet the extraordinary demand of €443 million; the Treasury will be refunding €260 million in the coming days.
Statistics indicate that 65 per cent of all MGS are either held by retail investors or financial institutions (banks). So if retail investors and banks, who already have high amounts of liquidity, are also in the market to purchase MGS, who will be selling via the QE window?
A further nine per cent is held by resident insurance companies which, most probably, would also be unwilling to sell their current MGS holding as the alternative investment options at the prevailing low yields will further disrupt their asset-liability management functions.
The Central Bank … will be required to purchase around €36 million per month in Malta Government Stocks
The ECB also revealed during last week’s press conference that it would also purchase securities with negative yields, so long as these are not below the ECB deposit rate at the time of purchase, currently -0.2 per cent.
Although since the initial announcement on January 22, sovereign prices across the eurozone (including Malta) continued to surge and yields tumbled, this latest aggressive stance by the ECB may indicate that prices may rise further during the initial phase of the QE programme.
On the other hand, it is worth noting that if any national central bank cannot purchase sufficient securities to fulfil its allocation, the ECB will allow substitute bond purchases in a specific list of a number of international and supernational institutions and agencies such as the Council of Europe Development Bank, the European Investment Bank, and various others. These substitute purchases should therefore enable the ECB to reach its €60 billion target each month across the eurozone. So local investors should not assume that the Central Bank will buy at all costs.
Moreover, although €36 million per month may be initially viewed as a large amount, an average value of €70 million per month was traded across the MGS secondary market during 2014, which increased to €82.7 million in January and a record €143 million last month.
Further price gains from the additional demand coming to the market may well instigate certain retail investors to realise some of the extraordinary gains on their MGS holdings. However, many will question where to invest the resultant funds in order to generate a regular income stream. Without adequate investment opportunities from the private sector, many retail investors will possibly still be reluctant to dispose of their MGS, irrespective of the price offered.
Other investors may, on the other hand, view this as an opportunity to reduce their long-term MGS holdings before some of these gains start to fizzle out. This is likely to happen once the QE programme comes to an end.
At a later stage, significant price drops can be expected from current levels, especially in the longer-term securities, once economic data begins to indicate that a recovery is gathering momentum as this would imply that interest rates will eventually start to rise. Although most international economists do not expect that rate hike before 2019, bond prices normally ‘react’ ahead of the event.
Given these unprecedented circumstances, market participants, regulators and other authorities need to openly discuss what measures are necessary to ensure a deeper capital market is in place that can fulfil the growing requirements of retail and institutional investors as well as support economic growth in Malta.
To facilitate this process, some regulations may need to be reviewed such as the free float requirement, i.e. the percentage of shares held in public hands when companies are conducting an Initial Public Offering.
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