1. Firstly, liquidity in the financial system has increased, both in
terms of excess reserves held by commercial banks and deposits held by
the non-financial sector, notably corporates, whose considerable
increase in gross debt has so far largely been offset by a similar rise
of liquid assets on aggregate;
2. Secondly, central banks have strengthened their presence in the
secondary sovereign debt market. This is a common and global feature.
The Eurosystem for instance, has reinforced its accommodative policy
stance notably by stepping up its asset purchases of public sector
securities under the pandemic emergency purchase programme (PEPP) while
continuing those under the asset purchase programme (APP). This implies
that a large proportion of the stock of some governments' debt -for the
major currencies- is currently held by central banks;
3. A third obvious factor lies in the significant increase in
sovereign debt issuances since last year, as European countries
implemented substantial fiscal measures to cushion the economic impact
of the Covid crisis and foster a subsequent recovery. All in all, euro
area governments issued close to EUR 1 trillion in net debt in 2020. It
is also worth noting that common debt issued under the SURE programme
(Support to mitigate Unemployment Risks in an Emergency) and even more
so the Recovery Fund will make the European Union one of the largest
debt issuers in Europe relative to national sovereign debt issuers over
the coming years.
These changes do not seem to have altered the good functioning of the
euro zone sovereign market. On the contrary faced with the economic and
financial shocks triggered by the corona virus pandemic, they have
fared well and proved resilient. They have consequently strongly helped,
with the banking system, governments and the Eurosystem to implement
forceful policies that have proved effective to help the private sector
to absorb those shocks. In my initial remarks today I would like to
highlight some dimensions of this resilience, looking in turns to bond
and the repo market but also highlight a few vulnerabilities and point
of attention from a financial stability standpoint that the role and
functioning of Eurozone sovereign markets during the crisis has also
revealed.
1. The resilience of European sovereign markets
a) Regarding the sovereign cash market, its
resilience during the crisis is first illustrated by financing
conditions, which have remained favorable since March 2020. In 2020,
yields on euro area country sovereign bonds continued to decline, to
record lows including for the euro area's most highly indebted
countries, despite the strong increase in debt issuances ; and the
dispersion of yield spreads between countries also narrowed. A number of
factors have contributed to this outcome, including flight to safety
flows, the presence of the Eurosystem on the secondary market, the hunt
for yield by investors, and the success of the first European common
debt issues.
Liquidity indicators also displayed good resilience. For instance,
the depth of the secondary market for French government negotiable
securities, measured by the average volume of daily transactions
(excluding Eurosystem purchases), has remained at a historically high
level,albeit at an increased transaction cost, more pronounced for
non-core sovereign debt markets, but at levels far below those of
previous crises.
The ownership structure of European debt securities has also
contributed to and reflects this resilience. According to data from the
ECB,
non-residents of the euro area were holding a significantand stable 44%
of euro area government debt at the end of 2020,willing to invest in
EUR, via highly liquid securities. Among residents, long term investors
are prominent investors : the central banks were accounting for 21% of
total outstanding debt, for the euro area, investment funds, insurance
corporations and pension funds were holding about 11%, while other
monetary financial institutions or banks for 19%.
b) Let me now turn to the repo market and its resiliency during the Covid crisis.
Under normal market conditions, the repo market is very liquid since
large banks dedicate specific balance sheet capacity for this activity.
The euro area repo market has also been largely unscathed by the
pandemic, remaining a fully functional market even at the peak of the
crisis. According to data from the International Capital Market
Association (ICMA), the total value of the outstanding repo contracts
has barely changed from December 2019 to December 2020 at EUR 8,300
billion (including both repo and reverse repo transactions). This is an
all-time high with a repo market size up by more than 40% in 10 years.
However, the euro area repo market can be affected by collateral
scarcity and seasonality, especially at the end of the year, considering
also the important share of Hold-to-maturity investors. In this regard,
Eurosystem has made available government bond holdings for securities
lending since April 2015. The Eurosystem securities lending programme
has been successfull in helping to normalize market rates and in acting
as a backstop facility for market participants. For instance, in April
2021, EUR 71.5 billion of public sector bonds were lent out on average
with a breakdown of EUR 59.5 billion against securities and EUR 12.0
billion against cash collateral.
Another key feature, which has helped to support the liquidity of the
euro area repo market, is the dominant share, two-third, of repo market
trading cleared via central clearing counterparties (CCP), despite the
absence of any mandatory clearing on these instruments. Consequently,
CCPs registered record volumes, in March 2020, in some case for more
than 15 trillions of euros, reflecting both cash raising transactions
but also special collateral borrowing transactions (notably for French
and German securities), leading for the former to temporary wider rates
and for the latter to tighter repo rates. Of note also, despite increase
in margins demands (associated with higher volumes), breaches and fails
have also remained very low.
The structure of repo clearing in Europe, significantly changed since
the migration in 2018–2019 of all euro-denominated sovereign debt
transactions from CCP LCH Ltd to the Paris-based LCH SA. With this
migration, around 700 billion euros have been transferred to LCH SA and
hence to an EU-based CCP.
Today, the European repo clearing sector is largely conducted in two
European CCPs, LCH SA which has a dominant market share and Eurex
Clearing.
From a financial stability perspective, this relocation of
euro-denominated repos within the euro zone is welcome, in particular
given the key role of these instruments, essential for government
funding. It ensures that this activity is subject to the stringent
requirements set by EMIR, under the close and integrated supervision of
national and European authorities through EMIR Colleges, and shields
this important funding market from any potential regulatory divergence
or supervisory conflicting interest between UK and EU competent
authorities. This successful migration of repo activity could serve as a
reference to shape future evolutions on other clearing segments that
are systemic to EU's financial stability.
In addition to clearing, the extended use of electronic platforms
also contributes to the resilience of the European repo market. As
mentioned in the last ICMA survey, the segment of the electronic repo
trading (via bilateral trading) in particular has benefited from the
turmoil observed during H1 2020 because of the dash for cash situation.
Nonetheless, support that voice-brokers can punctually bring to clients
has been also an important factor during these difficult times.
2. Some points of attention going forward
The resilience of the sovereign debt markets during the crisis and
their contribution to the absorption of the economic and financial
shocks we had to face, should not hide however a few attention point
that their development has contributed to intensify or bring back to the
forefront, from a financial stability perspective. I would like to
highlight two of them, margin calls and the sovereign-bank-corporate
nexus.
a) European sovereign debt is of course used as collateral to obtain liquidity on the repo market.
Episodes of volatility in times of crisis, like during the March 2020
market turmoil, or idiosyncratic events, such as the Gamestop or
Archegos ones, can result in significantly increased cash needs, in
particular stemming from margin calls across centrally cleared and
non-centrally cleared markets. The resilience of the repo market,
meaning its liquidity and depth, is thus critical in responding to those
margin calls, including for the non-bank financial sector.
Nevertheless, the ability to meet initial margins and variation
margins can pose severe liquidity constraints for market participants,
especially in non-banks financial institutions, and may thus exacerbate
liquidity stress in the system. The proper calibration of haircuts is
therefore essential so that in times of crisis they do not behave
procyclically and do not have to be increased abruptly.
Several international working groups are currently exploring the
issues related to margin requirements, in particular in the context of
the market turmoil observed in the early stages of the Covid crisis.
More recently, the default of Archegos on its margin calls, at the
end of March 2021, also highlighted the significant risks to which
certain banks were exposed through their services to non-bank financial
entities, through their prime brokerage activity. Both adequate
dimensioning of margins, and requirements of high quality collateral
prove critical. At the level of the European Union, the last step of the
compulsory use of the initial margins will come into force in 2022 in
application of the EMIR regulation, and should help contain such
developments. And the ESRB issued in June 2020 recommendations to
address liquidity risks arising from margin calls.
Nevertheless, we should remain alert and critical in terms of
supervisory actions and regulatory requirements to ensure that best
practices are enforced.
b) The second issue is the sovereign-bank-corporate nexus
European banks' ownership of sovereign debt has increased in the
course of the year 2020. These developments, coupled with the massive
public support targeting NFCs at the apex of the pandemic, and possibly
the room for carry-trade offered by the current design of liquidity
provided by the Eurosystem through TLTROs, have raised some concerns
about the sovereign-bank-corporate nexus. It is clear that in the future
this nexus could give rise to vulnerabilities from a financial
stability standpoint and we should remain vigilant about the negative
feedback loop that it may facilitate. However these concerns should not
be overstated. Let me observe first that in the Eurozone, these linkages
between banks, sovereigns and corporates have been crucial for
absorbing the economic and financial shocks created by the pandemic.
Second, the growth in the intensity of these interlinkages must be
put into perspective. For instance, relative to their total assets,
banks' exposure to their domestic sovereign have only increased modestly
and has remained well below their historical peak.
And third, if the so-called bank sovereign "doom loop" was a
significant threat for the Eurozone after the Great Financial Crisis, we
must reckon that this time is different, and that this threat has been
weakened.Indeed, the pandemic crisis does not originate from banks, and
banks are materially more resilient compared to what they were in 2008
thanks to the implementation of Basel III. And thanks to the
implementation of the Banking union in its various dimensions, spillover
risks have been reduced. Bail-in capacities of French banks for
instance have significantly improved over the last decade, reducing the
likelihood of a bail out – which would in any case be subject to the
rules of the Banking union's resolution pillar.
And finally, the possible negative impact on the financial stability
outlook will crucially depend on the strength and sustainability of the
recovery underway and the policies which will be implemented to preserve
public debt sustainability.
So let me stop there for these initial remarks. Thank you for your attention.