Bidding at Canadian government-bond auctions is declining to the lowest level in at least two years as foreign banks retreat from the nation’s debt markets amid increased regulatory constrictions and diminished price swings.
Deutsche Bank AG (DB:US) and Morgan Stanley (MS:US) stopped submitting bids at Bank of Canada auctions in the past three months, according to people with knowledge of the change who asked not to be named because they hadn’t been authorized to discuss it publicly. The central bank declined to comment on the U.S. and German banks or any drop in bids, Louise Egan, a spokeswoman, said in an e-mail.
Bids at last week’s C$3.4 billion ($3.1 billion) auction of two-year bonds outstripped the amount of debt sold by 2.29 times, the lowest bid-to-cover ratio since February 2012, data compiled by Bloomberg show. The ratios for the most recent auctions of five- and 10-year bonds were the least since 2010.
“Clearly these dealers no longer being involved in the market had an impact,” Roger Quick, director of fixed-income research at Bank of Nova Scotia, said in an Aug. 14 phone interview from Toronto. “I don’t think the impact is that problematic at the moment, but if it continues and Canada starts running up larger debts again, it may become a problem.”
As regulations implemented after the 2008 global credit crisis take hold, foreign banks are becoming more selective with what businesses they partake and what securities they hold on their balance sheets, causing a general retreat from Canadian debt markets, according to research firm Greenwich Associates.
“That could become a concern for liquidity going forward,” said Quick, adding the decline in bidding cannot be explained away by summer vacations as Bank of Nova Scotia analysis suggests there’s little seasonality to auction activity. “The point of having an auction is you want to have broad distribution, so at some point if you don’t have that, you have a problem.”
Bank of Nova Scotia participates in the central bank’s debt sales.
Quick points out average borrowing costs at all the recent debt sales decreased from the previous ones, suggesting that even with less competitive auctions, investors are willing to pay a premium for the safety of Canada’s AAA rated debt.
The average accepted yield at the latest auction of two-year notes fell to 1.09 percent, from 1.12 percent at the previous sale, according to data compiled by Bloomberg. The average yield at the Aug. 6 five-year bond auction dropped to 1.55 percent, from 1.74 percent at the previous offering, and the July 23 10-year bond auction saw yields fall to 2.23 percent, from 2.37 percent.
The bid-to-cover ratios at all three auctions were below their long term averages dating back to 2005, according to data compiled by Bloomberg.
The Bank of Canada has two designations for firms that participate in its government debt auctions: government securities distributors, which are eligible to bid, and primary dealers, which can make bigger bids and whose bidding must also exceed a certain threshold. The dealers that participate in the auction can then distribute the securities they receive to their clients in Canada and abroad.
Morgan Stanley ceased to be a government securities distributor when it closed its Canadian fixed-income desk in June, according to a person with knowledge of the matter.
Deutsche Bank ceased to be a primary dealer in July, according to a different person with knowledge of the matter.
Amanda Williams, a New York-based spokeswoman for Deutsche Bank and Mark Lake, a spokesman in New York for Morgan Stanley, declined last week to comment on their banks’ involvement in the auction process.
There are currently 11 primary dealers and 20 government securities distributors, the Bank of Canada website shows.
“Primary dealers are required to meet a certain bidding limit,” Ruslan Bikbov, a fixed-income strategist in New York at Bank of America Corp., said Aug. 15 by e-mail. “The fact that the two banks left the process could result in some decline in bid-to-cover ratio.”
Bikbov said the bid-to-cover ratio is volatile and over a longer timeframe the recent drop doesn’t look extreme.
While geopolitical crises from the Ukraine to Iraq have spurred a rally in Canadian government debt, with investors’ quest for safety sending yields on the country’s benchmark 10-year bond to the lowest in more than a year on Aug. 15, the longer-term trend has seen foreign investors selling rather than buying the securities.
Foreign investors have sold a net C$8.5 billion of federal government debt in the past six months as faster global growth diminishes Canada’s haven appeal, according to data compiled by Bloomberg.
The declining foreign interest in Canadian government debt comes amid leaner times in the fixed-income business worldwide.
Volatility (VIX) close to record lows has limited traders’ ability to profit from price swings, while new capital rules globally are forcing banks to hold more equity against their fixed-income positions. A proposed leverage ratio in the U.S. and Europe extends those higher capital requirements even to holdings of safer government bonds.
That’s squeezed margins and caused banks to scale back Toronto-based fixed income operations, Greenwich Associates said in an Aug. 11 release.
Foreign investors that bought Canadian government debt through Deutsche Bank or Morgan Stanley may shift their business to domestic banks, and any dip in auction activity may be temporary, said Adrian Miller, director of fixed-income strategies at GMP Securities LLC. Foreign institutions’ declining activity in Canadian debt markets may not be.
“Banks are backing out of the Canadian market from a business perspective,” Miller said by phone from New York. “They’re just not making enough money.”
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