Pspp's implementation rules

PSPP’s implementation rules: impact on markets and

challenges ahead

Cristiana Corno, Rates Strategist, Global Markets-Trading, Banca IMI

Fabrizio Ligurgo, Internship Strategist, Global Markets-Trading, Banca IMI

15th July 2016

Bis (March2016 Quarterly Review) calculates that 5.3 trillion € value in bonds are trading

at negative yield or 25% of the Boa Merrill Lynch world Sovereign index.

At G7 level, an amount of approx. 9 trillion € is trading at negative rates, or 30% of

the total outstanding amount (fixed coupon bonds).

Negative yields unconventional … but contagious

2

Source: Bis Quarterly Review (March 2016)

Amount of debt trading at negative yield, using as

reference the Boa Merrill Lynch world Sovereign index. Debt amount trading at negative yield in G7: amount and

percentage on total outstanding

Source: Bloomberg data, Banca IMI calculations

0%

5%

10%

15%

20%

25%

30%

35%

0

1

2

3

4

5

6

7

8

9

10

Tri

llions

Outstanding Amount (value)

Outstanding Amount (%)

It is interesting to look at each bond market as if they were portfolios: average yield to

maturity has diminished and interest rate risk in the market has increased delivering

a low risk/reward asset

Bonds: unconventionally low risk reward

3


Weighted average yield (issue’s outstanding amount) of

selected markets.

Increase in G7 market outstanding weighted duration and

decrease in weighted average yield

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

5

5.2

5.4

5.6

5.8

6

6.2

6.4

Duration

Weighted yield

Weighted average yield

Switzerland -0.66

Germany -0.38

Japan -0.21

Netherlands -0.30

Austria -0.27

Denmark -0.12

France -0.12

Sweden -0.19

Belgium -0.11

Ireland 0.01

Spain 0.56

Italy 0.66

Portugal 2.10

At EU level, an amount of approx. 3.2 trillion € is trading at negative rates, or 50%

of the total outstanding amount (fixed coupon bonds).

Negative yields in EU

4

Weighted yield and duration in EU fixed income markets Debt amount trading at negative yield in the Eurozone:

amount and percentage on total outstanding


0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

6.4

6.6

6.8

7.0

7.2

7.4

7.6

7.8

8.0

Weighted Duration

Weighted Yield

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

1.0

1.5

2.0

2.5

3.0

3.5

Tri

llions

OutstandingAmount (value)

Unconventional … driving asset allocation decision

5

Source: Banca IMI calculations

Swiss private sector change in asset allocation decision

At country level, we can expect some shift from fixed income to alternative/managed

funds as it happened in Switzerland (shifting from bonds to UCITS funds, with the

allocation to equities almost unchanged).

Assets for exclusive players

6

Italian debt percentage holdings 2008-2015 (Bank of Italy data) Italian interest expenses as percentage over GDP (Mef data

1990-2009). Currently at 4.2% of GDP

If low yield levels represent a short term benefit for the governments in terms of lower

interest rate spending, they also change the structure of the market by reducing

significantly the number of active players.

In Italy, the share of government debt held by domestic non financial agents fell from

20% in Jan 2008 to 5.0% in Feb 2016, with banks, insurers and central banks

increasingly filling the gap.

22%

26%

21% 5%

0.0%

25.0%

50.0%

75.0%

100.0%

Jan 08 Jan 10 Nov 11(debtcrisis)

Nov 12 Jun 14ECB

depo cutto -

0.10%

Dec 14ECB's QE

Dec 15ECB'sQE2

Feb 16

Other residents Other FI Banks Non residents


In Italy: higher holding, higher correlation?

7

Increased market correlation (Bloomberg data)

Since the beginning of the year, the correlation between Btp-Bund spread and financial

risk has increased, notwithstanding EBRRD adoption.

Source: Bloomberg Data

Evolution of holdings in main Europeans

8

0%

10%

20%

30%

40%

50%

60%

70% GERMANY

Central Bank Credit Institutions

other domestic non banks Non-residents

0%

10%

20%

30%

40%

50%

60%ITALY

Central Bank OMFIs

Other financial institutions Other residents

Non-residents

0%

10%

20%

30%

40%

50%

60%SPAIN

Central Bank OMFIs

Other financial institutions General government

HHs and NPISHs Rest of the world

non-financial corporations

0%

10%

20%

30%

40%

50%

60%

70% FRANCE

insurance companies credit instituions OPCVM money funds

other residents non-residents

Source: CB’s and Bruegel http://bruegel.org/2016/05/sovereign-bond-holdings-in-the-euro-area-the-impact-of-qe/

Rest of

the world

up

Residents

down

http://bruegel.org/2016/05/sovereign-bond-holdings-in-the-euro-area-the-impact-of-qe/





















Hot Topic: Bund scarcity issue

9

How many months Bundesbank to exhaust the pool of eligible bonds?

We tried an empirical approach, under 2 assumptions:

our universe is the pool of German securities available for lending at ECB and

bilateral lending (approx. 1.1tr nominal, 1.3tr countervalue): sovereign, agencies and

regional bonds.

we have assumed that the CB, solves an optimization problem in determining the

nominal amount of each bond, in order to minimize the Mean Squared Error, where

the mean is the average percentage of nominal purchased on issue’s

outstanding.

Under these assumptions, and the constraints of matching the amount and the

duration bought by the CB and communicated monthly, we have built a PSPP replicating

portfolio.


Possible maturity distribution and sector composition-

overall portfolio

Average duration of main CB’s purchases under QE,

ECB data

Hot Topic: Bund scarcity issue

10

Currently the pool of eligible is 230bn (value) reduced to 95bn due to depo limit, equivalent

(assuming 15b a month) to 6.32 months to exhaustion. BUT:

the length to exhaustion is a function of the yield level;

the eligible bonds are high duration bonds: the exhaustion of the pool will increase

the portfolio duration from 7.45 to 11.4 and the govies percentage from 65% to 74%.


Change in yield from current level and months to exhaustion

0

2

4

6

8

10

12

14

16

0

50

100

150

200

250

0.5 0.4 0.3 0.2 0.1 0 -0.1 -0.2 -0.3 -0.4 -0.5

Bill

ions

months pool y>depo

Eligible pool composition – only long end bonds

duration 7.4460

agencies 31%

govt 65%

regional 4%

duration 11.3973

agencies 23%

govt 74%

regional 3%

Hypo replicating portfolio: agencies

11

The agencies replicating portfolio we obtained has a lower duration (4.5 versus 7.45

overall portfolio) compared to the entire portfolio.

Almost all the securities in the portfolio have reached the 33% cap. Due to the yield

constraint, an eventual increase in the issuer cap for non Cac bonds will only increase the

purchase in the long end.


Possible maturity distribution - agencies portfolio Almost all the securities have reached the 33% cap

Avaiable nominal to buy if cap is increased to 40% (agencies only)

Hypo replicating portfolio: bunds

12

The bund portfolio has a higher duration (8.9) and it is made up by 42% Cac-ed securities

(58% not Cac-ed). The buying has been probably concentrated in 7-10y bucket.

In the Bund portfolio, the most of the securities has not reached the 33% cap but the yield

constraint limits possible purchases to the long end. If Buba were to buy the residual

securities, the portfolio duration would increase from 8.9 to 13.7


Possible maturity distribution - bund portfolio Bund purchases have been probably concentrated in 7-10y

Avaiable nominal to buy on the Bund curve - long end only

Hypo replicating portfolio: regionals

13

The regional portfolio has a lower duration (6.85) and it is probably already capped at

33%.

Due to the higher yield level, an increase in issuer limit will increase the amount of

regional buying along the overall curve.


Possible maturity distribution – regional portfolio Regional bonds are already capped at 33%

Avaiable nominal to buy on the regional curve – if cap increased to 40%

14

As shown in table below, an increase in the issue cap would not change

significantly the number of months to exhaustion.

At current yield level, the change will increase the amount eligible in the long end

of the bund curve, therefore increasing the overall portfolio duration.

Change in eligible pool if issue cap is increased to 40% and

50% on non Cac-ed securities


Increase of issue cap for non Cac securities

ISSUE LIMIT

40% 50%

All 9 (+2.5) 12.4 (+6)

Only non-Cac

8 (+1.7) 10.2 (+4)

Months to exhaustion in case of QE terms

rearrangement (increase from current situation)

0

2

4

6

8

10

12

Bill

ion

s

33%

40%

50%

duration 7.4460

agencies 31%

govt 65%

regional 4%

duration 12.6025

agencies 22%

govt 74%

regional 4%

15

The non Cac-ed securities in the long end are trading very rich. However, if

yield were to increase or depo limit to be removed, while increasing the

cap to 40% on non Cac-ed securities, the amount to be bought would

change along the curve (chart below) and it could possibly richen the non

Cac-ed securities in the mid part of the curve.

Change in eligible pool if issue cap is increased to 40% and yield

limit is not more binding anymore


Increase of issue cap for non Cac securities: possible

trade

-

1

2

3

4

5

6

7

8

9

Bill

ions

Bond Name Las t av g min max s tdev ze ta

BKO 0 09/15/17 0.00 0.00 -0.50 0.00 0.04 Cacs

OBL 0 1/2 10/13/17 -0.01 -0.72 -3.64 1.09 0.94 0.75

BKO 0 12/15/17 0.00 -0.01 -0.39 0.00 0.05 Cacs

DBR 4 01/04/18 -3.74 -1.68 -5.12 0.19 1.29 -1.60

OBL 0 1/2 02/23/18 0.00 0.00 -0.35 0.00 0.02 Cacs

BKO 0 03/16/18 0.00 0.00 0.00 0.00 0.00 Cacs

OBL 0 1/4 04/13/18 0.00 0.00 -0.29 0.00 0.01 Cacs

BKO 0 06/15/18 0.00 0.00 0.00 0.00 0.00 Cacs

DBR 4 1/4 07/04/18 -0.40 -0.92 -5.19 1.92 1.79 0.29

OBL 1 10/12/18 0.00 0.00 -0.36 0.00 0.02 Cacs

DBR 3 3/4 01/04/19 -0.20 -1.17 -5.59 1.95 2.11 0.46

OBL 1 02/22/19 0.00 0.00 -0.36 0.00 0.02 Cacs

OBL 0 1/2 04/12/19 0.00 0.00 -0.22 0.00 0.01 Cacs

DBR 3 1/2 07/04/19 1.21 -1.06 -5.52 2.95 2.50 0.91

OBL 0 1/4 10/11/19 0.00 0.00 -0.05 0.00 0.00 Cacs

DBR 3 1/4 01/04/20 0.25 -1.52 -5.94 2.17 2.41 0.73

OBL 0 04/17/20 0.00 0.00 -0.16 0.00 0.01 Cacs

DBR 3 07/04/20 1.50 -1.62 -6.01 2.15 2.36 1.32

DBR 2 1/4 09/04/20 -2.07 -2.40 -6.32 0.93 1.69 0.19

OBL 0 1/4 10/16/20 0.00 0.00 -0.21 0.00 0.02 Cacs

DBR 2 1/2 01/04/21 -0.68 -1.73 -5.39 1.20 1.78 0.59

OBL 0 04/09/21 0.00 0.00 0.00 0.00 0.00 Cacs

DBR 3 1/4 07/04/21 -0.42 -1.51 -5.07 1.80 1.62 0.67

DBR 2 1/4 09/04/21 -1.21 -1.90 -5.11 0.42 1.42 0.49

DBR 2 01/04/22 -0.68 -1.28 -4.12 1.59 1.14 0.52

DBR 1 3/4 07/04/22 -0.81 -1.24 -3.13 0.77 0.76 0.57

DBR 1 1/2 09/04/22 -0.36 -0.50 -2.34 1.00 0.58 0.23

DBR 1 1/2 02/15/23 0.00 0.00 0.00 0.87 0.04 Cacs

DBR 1 1/2 05/15/23 0.00 0.00 0.00 0.53 0.03 Cacs

DBR 2 08/15/23 0.00 0.00 0.00 0.62 0.03 Cacs

DBR 6 1/4 01/04/24 -0.13 -0.09 -4.20 4.34 1.98 -0.02

DBR 1 3/4 02/15/24 0.00 0.00 0.00 0.53 0.03 Cacs

DBR 1 1/2 05/15/24 0.00 0.00 0.00 0.74 0.04 Cacs

DBR 1 08/15/24 0.00 0.00 0.00 0.54 0.03 Cacs

DBR 0 1/2 02/15/25 0.00 0.00 0.00 0.39 0.02 Cacs

DBR 1 08/15/25 0.00 0.00 0.00 0.65 0.05 Cacs

DBR 0 1/2 02/15/26 0.00 0.00 0.00 0.00 0.00 Cacs

DBR 0 08/15/26 0.00 0.00 0.00 0.00 0.00 Cacs

DBR 6 1/2 07/04/27 -6.23 1.56 -7.08 6.89 2.83 -2.75

DBR 5 5/8 01/04/28 -8.71 2.48 -9.18 9.52 3.94 -2.84

DBR 4 3/4 07/04/28 -10.39 1.42 -10.94 8.15 4.09 -2.89

DBR 6 1/4 01/04/30 -12.03 2.59 -13.38 13.19 6.01 -2.43

DBR 5 1/2 01/04/31 -8.07 5.25 -9.94 13.77 4.91 -2.71

DBR 4 3/4 07/04/34 -10.43 3.19 -11.63 11.58 5.01 -2.72

DBR 4 01/04/37 -8.37 3.32 -9.43 10.28 3.89 -3.00

DBR 4 1/4 07/04/39 -4.71 3.06 -5.99 8.87 2.77 -2.81

DBR 4 3/4 07/04/40 -2.24 3.32 -3.97 8.35 2.29 -2.43

DBR 3 1/4 07/04/42 -2.05 0.05 -3.61 2.57 1.27 -1.65

DBR 2 1/2 07/04/44 -2.17 -1.47 -4.07 0.51 1.11 -0.63

DBR 2 1/2 08/15/46 0.00 0.00 0.00 0.67 0.03 Cacs

16

The removal of the yield limit would increase the most the eligible universe: from

6.3 to 15 month with 33% cap unchanged.

Moreover, in this case, the eligible pool is spread on the curve and through

sectors. The exhaustion of the eligible pool in this case would result in a more

balanced portfolio.

Change in eligible pool of Bunds if yield limit is removed


Removal of yield limit

Months to exhaustion in case of yield limit removal

and increase in issue cap

-

1

2

3

4

5

6

7

8

Bill

ions

duration 7.4460

agencies 31%

govt 65%

regional 4%

duration 8.6390

agencies 15%

govt 83%

regional 2%

ISSUE LIMIT

33% 40% 50%

15 (+9) 19.5 (+13) 25 (+19)

17

The yield removal could be realized by constraining the average yield

portfolio rather than the single issue yield to maturity.

Under our assumptions and calculations, the historical yield to maturity of Buba

portfolio should be around 0.18-0.07%; therefore, there is ample room to buy

bonds yielding less than -0.40%. This expedient would have similar effect as

the yield removal (up to a certain negative yield level and depending on the

expected size of the portfolio).

Historical Buba hypothetical portfolio yield to maturity – still positive


Removal of yield limit: from issue to portfolio

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

18

A removal of the yield limit would possibly cheapen the long end of the German

curve. Possible trades:

3010y cash steepening versus swap flattening

Cheapening of 2034-2037 securities versus non Cac-ed securities (fly below)

Short Buxl asset swap versus long ITRX Xover protection.

15y-20y area cheapening trade


Removal of yield limit: possible trades

Divergence between Bunds asset swap level and Credit proxy

19

In table, we show how things would change, assuming buying based on relative

“sovereign only” market size, rather than capital key. Italy increases the most in absolute

and relative value, followed by France; the amount of purchasing in Germany is reduced

by 33%, from 15b to 10b, monthly.

The number of months would increase to 3, so the scarcity issue is not efficiently

addressed.

Change in PSPP relative buying


From capital to sovereign quote

Germany -5b monthly

Italy +5b monthly

20

Long Btp-Bund spread with duration short 30% of spread trade DV01, suggested at

0.96 as a defensive play. Original stop 1.06, target 0.80.

Long Btp versus short Bund in 10y maturity (0.7 versus 1 DV01 weights)


Trade works in a risk-on scenario.

From capital to sovereign quote: possible trade

21

Disclaimer

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22

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lending and securities industry, carrying out in particular – through its companies in possession of the necessary authorizations, where required –

investment banking, corporate finance and finance and investment activities – through merchant banking activities and proprietary trading -

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having, at any time, significant directional positions, long or short, trading activity which could be also contrary to the views expressed herein; ii)

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In consideration of the above, Banca IMI S.p.A. states that has adopted written guidelines “Modello di Organizzazione, Gestione e Controllo” pursuant to

Legislative Decree June 8, 2001 n. 231 (available at the Intesa Sanpaolo website, webpage

http://www.group.intesasanpaolo.com/scriptIsir0/si09/governance/ita_wp_governance.jsp, along with a summary sheet, webpage

https://www.bancaimi.com/en/bancaimi/chisiamo/documentazione/mifid.) setting forth practices and procedures, in accordance with applicable

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information, namely inside and/or confidential information, to prevent misuse of such information and to prevent any conflicts of interest may

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Pspp's implementation rules

Economy & Finance

Transcript of Pspp's implementation rules