The Eurozone welcomes Ourobouros

This is the sort of thing that cannot go on forever:

The European Financial Stability Facility (EFSF) last week announced it had successfully sold a €3bn 10-year bond in support of Ireland.

However, The Sunday Telegraph can reveal that target was only met after the EFSF resorted to buying up several hundred million euros worth of the bonds.

Sources said the EFSF had spent more than € 100m buying up its own bonds to help it achieve its funding target after the banks leading the deal were only able to find about €2.7bn of outside demand for the debt.

You can see the obvious problem: buying your own debt at issue doesn\’t in fact raise you any money.

Which really is something of a problem for an entity that wants to borrow €1 trillion and finds it difficult to get a €3 billion issue away.

There is however a wrinkle to this story. One that rather depends upon whether the Telegraph understands how bonds are issued.

You\’ve got your lead managers. They build the book, find the people who are going to take the newly issued bonds. As part and parcel of that exercise they almost always (almost, but not quite) take some of the new issue onto their own books. Onto a trading book that is, not into their own hold to maturity funds (which they might do as well but that\’s an entirely separate part of the operation).

The reason for this little trading float is that for the first few weeks of the bond issue, they want there to be a nice liquid market. They want people who missed the original issue to be able to get some. Want those who were a tad enthusiastic to be able to reduce their holdings, cleanly and simply without moving the price too much. So, they hold some percentage of the issue (and perhaps one of our financial sector readers could tell us what sort of percentage is normal) as a market making float. They can keep the market liquid for a few weeks, then they\’ll wind it down and find permanent homes for this last small portion of the issue.

Why? Because most bond issues are really quite illiquid. A €3 billion issue by the EFSF, a couple of months after issue, most of it will be in hold to maturity funds. Not much trading of it, any big sale or purchase would move the price considerably. So, the lead managers will deliberately keep a portion of the issue in order to have a liquid market for those first few weeks in order to settle everything down.

Don\’t forget, when someone says \”the Japanese\” bought some, we\’re not (necessarily) saying that Japan, or even the Bank of Japan bought some. We\’re saying that under those lead managers some Japanese bank agreed to take €100 million or €300 million of the issue. They will then act again as a manager, passing the bonds along to various Japanese investors, to insurance companies, pension funds, yes, even individual private investors (don\’t know about EFSF bonds but Eurobonds usually can be bought in €1,000 pieces). This takes time and that junior manager of the issue might find demand greater than they had expected: or of course lower.

So there\’s a deliberate engineering of a reasonably liquid market in the first few weeks of an issue so that all these estimations can be shaken down into real placings of the bonds with final investors. This is done by keeping some of the issue in the hands of the lead managers. Or, if you squint at it, \”bought by the issuer\”.

So, that\’s where the question comes in. Has the EFSF really had to buy in €100 million or more of their €3 billion issue? Or is the Telegraph just looking at the entirely normal practice of having a market making float for a bit?

No, I dunno either: although there was a little squeak on Alphaville earlier in the week. The lead managers stating that they only had the entirely normal float. Meaning, of course, that they had rather more than that entirely normal bit left over.

5 comments on “The Eurozone welcomes Ourobouros

  1. But are those actually considering the bonds as investment normally aware of the practice–or of the size of those purchases in each individual case. To a certain extent, it appears that the intent–or one of the intents of the purchases is actually to mislead “the market” as to the desirability of the bonds themselves.

    In the 1860s, a French financial firm was used by the Confederate States of America to issue
    their bonds on the European market. The firm (Erlanger) persuaded the CSA to buy a large
    block of the issue themselves (to include commission to themselves) in order to make them appear more attractive on the market than actual. Then, when the bonds still didn’t pick up steam (probably because of news of the military situation), they were able to persuade them to buy additional quantities. All said and done, CSA was almost the only buyer, materially adding to their ruin. Erlanger did OK, I guess.

  2. interesting to observe how often blogs are taken over by their commentators…zero hedge has followed Big Picture (though to be fair Barry has returned to balance more recently) in becoming an echo chamber for conspiracy theorists, gold bugs and equity bears who regards bond markets as all seeing and equity markets as compltely rigged and stupid. Any failure of predicted armageddon in equities or the $ is blamed on the mythical plunge protection team and fixed income and gold are always going higher. The anlysis is not entirely wrong, but the hysteria is far from helpful to the non day trader

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