Italian Public Debt Management: The secondary market

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1 Italian Public Debt Management: The secondary market Rome May 31, 2007 Mr. Alessandro Cascino and Mr. Roberto Di Veglia Treasury Department - Public Debt Directorate Italian Ministry of the Economy and Finance

2 Contents Historical evolution of the Italian secondary market Current structure of the regulated secondary market MTS, BondVision, MMF-Repo and MOT Benefits of the regulated secondary market Page 2

3 Historical evolution of the Italian secondary market Page 3

4 Primary and secondary market I MTS S.p.A. was the first electronic market for government bonds It was founded in 1988 and privatised in 1997 The main reason for the launch of MTS was to create a supportive environment for the big changes that were ongoing in the primary market, namely the evolution in the placement technique of government bonds From a system of firm sale to a predetermined group of banks to an auction based system, where all market players can participate and bid competitively for the amount of bonds announced by the issuer Page 4

5 Primary and secondary market II This market oriented approach consisted of regular auctions, (independent from any view on interest rates) and enhanced transparency of information and procedures: auction annual calendar (1994) increased dialogue and exchange of information with market makers (1994) regular contacts with selected groups of institutional investors (1998) quarterly bulletin (1999) internet website of the Debt Management Office (1999) Specialists in Government bonds (1999) Page 5

6 Goals to be achieved through the MTS The measures to create an efficient secondary market, were adopted within the general framework of public debt management policy, aimed at achieving a structural minimization of funding cost The goals to accomplish with the new trading system were: greater liquidity for Government bonds, through an enhanced network which makes transactions very easy to be executed clear picture of market conditions for the market participants, by means of a continuous on screen availability of bid-offer prices better forecast of the market conditions, to help the issuer in the placement of specific bonds offered at auctions Page 6

7 The screen based secondary market MTS was created to provide a network for electronic trading of Italian government securities In order to participate to the system, financial institutions had to adhere to the market signing an agreement. The main feature of the new system consisted in the possibility for operators to unload even large positions: 1) in any market condition 2) at clear and reliable prices 3) at the least possible cost (through reduced bid/offer spreads) Page 7

8 Laws and regulations Through a legislative measure, the Treasury laid down the general framework in which the new market was to operate, leaving the technical aspects to be regulated by the market participants themselves. Nowadays, the main legislative source is a Ministerial Decree (D.M. 13 May 1999, no. 219), concerning: The authorization of wholesale markets for Government bonds, the market regulation and management The vigilance on the markets and on their managing companies The Specialists in Government bonds Page 8

9 Recent developments I At the end of 1997 the Treasury completely pulled out of the market management. MTS was totally privatized and the management of the screen based market became a private business MTS equity base was sold to the major market makers in the Italian government bond secondary market; by then, the category of market makers started including an increasing number of foreign institutions The majority of shares in the company are now owned by an holding (a joint venture between Euronext N.V. and Borsa Italiana S.p.A.) Major international financial institutions hold the remaining shares Page 9

10 Recent developments II The Treasury no longer holds any stake nor interest in the management of MTS Nowadays MTS is a regulated market that provides wholesale electronic trading of Italian government bonds and other types of fixed income securities It is supervised by the Italian Ministry of the Economy and Finance, the Bank of Italy and the CONSOB The supervisory board includes members appointed by the shareholders and a representative of the Treasury Page 10

11 Current structure of the regulated secondary market Page 11

12 MTS today MTS is a wholesale market, where cash, strips and repo are traded: membership is limited to institutional intermediaries, with minimum amount requirements for trading. Anonymity: the counterpart is disclosed only after trade is executed Liquidity of bonds traded and depth of the market: market makers are subject to quoting obligations and must trade large volumes in all circumstances Transparency: MTS provides clear information about best prices and latest trades, also through real-time market statistics Efficiency: auto-matching of proposals is provided and pending orders are aggregated Quickness: around 3 seconds are required to enter an order manually and less than 1 second for the effectiveness of a quotation change (parallel transactions enable all quotes to be changed at the same time) Page 12

13 Participant requirements MTS participants are divided in 2 groups: 1) Market Makers 2) Market Takers Participant requirements are: 1) Market Makers: eligible financial institutions must have net assets of at least 39 million and have traded at least 38 billion in bonds quoted on MTS in the preceding year 2) Market Takers: eligible financial institutions must have net assets of at least 10 million Page 13

14 MTS: Market making obligations I Primary Dealers must commit to the following market making obligations: Bonds assigned to Primary Dealers for obligatory quotation are allocated by type of security, maturity and liquidity Each Primary Dealer is assigned 20% of each type/liquidity class of Italian government issues listed (BOTs are not included) Assigned bonds are reallocated on a monthly basis Two-way proposals (bids/offers) must be displayed for all bonds assigned for at least five hours per day Page 14

15 MTS: Market making obligations II The following quoting obligations apply: Segment Bucket Liquid (ticks) Not Liquid (ticks) BTP A (<3.5yrs) 4 7 B ( yrs) 5 12 C ( yrs) 7 16 D (>13.5yrs) CCT No bucket 5 12 CTZ No bucket 4 No market making obligations apply to market takers. Page 15

16 Page 16 The screen based procedure

17 MTS, BondVision, MMF-Repo and MOT Page 17

18 The business-to to-client platform MTS also offers a multi-dealer-to-client (B2C) electronic bond trading market, called BondVision BondVision was launched in 2001, in response to continued requests from institutional investors for access to the liquidity of the MTS markets The platform provides real-time tradable prices from the leading MTS market makers Clients access the platform using an Internet based technology and are enabled to auction their business with up to 5 dealers online The philosophy of BondVision is to provide price discovery (as an alternative to transaction via telephone and other over-the-counter trades) BondVision is a regulated market and is subject to the same supervision applied to MTS Page 18

19 Page 19 The regulated wholesale Repo market A Repo trading facility is also available on the MTS platform called MMF-Repo (Money Market Facility - Repo) It allows buy and sell back on Italian government bonds, classic repos and buy and sell back on non-italian Government bonds and non- Government bonds Provides users with the functionality to trade repos electronically, thus enabling the simultaneous management of both repo and cash securities trading All securities traded can be object of repurchase agreements; two types of contracts can be negotiated: Special repos and General collateral repos There is no role distinction among the participants and there are no quoting obligations on the regulated wholesale Repo market Beside the 43 market makers of MTS and 63 market takers, there are 13 dealers that are only active on the Repo segment (mainly funds and insurance companies)

20 The wholesale and retail regulated markets Elevated minimum lots on MTS: Proposals must be formulated for a minimum quantity equal to Euro 2.5 or 5 million depending on the instrument (bucket of maturity, liquid/not liquid security) Orders may be submitted for Euro 2.5 million and multiples with automatching Do not forget that MTS Italy is a wholesale market. In Italy there is also a retail regulated secondary market for Government bonds and other securities, called MOT (managed by Borsa Italiana S.p.A.) On the retail markets the minimum lots are usually around 1,000 euro Page 20

21 MTS share on the secondary market In 2006, MTS share of the Italian Government bonds secondary market was over 70% MTS Other markets and OTC MTS's share of the value to be settled on Italian Governement Bonds (Data in million of Euro) Page 21 0 January February March April May June July August September October November December Source: Monte Titoli

22 Benefits of the regulated market I For dealers: market structure allows primary dealers to participate in the market governance low transaction costs reduce trading expenses a single platform simplifies IT efforts automated settlement reduces back office costs For final investors: no direct access to the wholesale market, but indirect benefits from the benchmark role covered by MTS tighter spreads clear market conditions Page 22

23 Benefits of the regulated market II For the issuer: Wider market distribution enhances liquidity, that boost spread convergence The central trading platform provides valuable feedback Ease of access favors appeal of bonds, particularly for foreign institutions (and therefore the allocation of Italian Government bonds to foreign investors) The efficient secondary market guarantees a steady, reliable demand for bonds at auctions and, in general, an easier management of debt Page 23

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