Implementing QE in Malta

Financial Article 374 by Edward Rizzo - Mar 12, 2015

Following the announcement by the European Central Bank on 22 January about the launch of its €60 billion per month quantitative easing (QE) programme starting in March 2015, many questioned how QE will be implemented in Malta.

Executives of the Central Bank of Malta entrusted with the QE programme held an information meeting last week to explain the procedures to be undertaken for the implementation of the QE programme, or as it is now referred to, the Public Sector Purchase Programme (PSPP).

My article of 29 January had provided an explanation of what QE means and the implications for investors due to the expected resultant decline in yields, currency weakness and positive performance of equity markets.

The Central Bank confirmed that it will be required to purchase a value of around €36 million per month in Malta Government Stocks between March 2015 and September 2016. After the monetary policy meeting of last Thursday, the President of the ECB Mr Mario Draghi announced that the QE programme was scheduled to start last Monday 9 March. Meanwhile, as indicated in January, the period until when the QE programme will last is not definite. The Central Bank representatives highlighted that the ECB promised that it will continue to purchase €60 billion worth of assets across the eurozone until inflation shows signs of approaching the 2% level.

Any national central bank across the eurozone is allowed to purchase sovereign bonds with a maturity profile ranging from 2 years to a maximum of 30 years. Naturally, since the longest-dated MGS matures in 2040, the Central Bank of Malta needs to limit any purchases to a maximum maturity of 25 years. An important consideration for retail investors is that the QE programme will only be eligible for minimum quantities of €100,000 (nominal) per MGS and therefore investors holding amounts less than this in any particular security cannot take advantage of this programme. Another important fact is that the ECB (via national central banks) will only buy in the secondary market and therefore they will not be competing with other investors for new issues on the primary market.

Retail investors holding less than €100,000 nominal in any MGS would need to continue trading their MGS on the regular secondary market and the Central Bank made it a point to highlight that this QE programme will not conflict with its market making function which will continue to be provided on a daily basis as we have been accustomed for many years.

“…the QE programme will only be eligible for minimum quantities of €100,000 (nominal) per MGS…”

In order to take advantage of the QE programme, a member of the Malta Stock Exchange (a broker) would need to negotiate with the QE desk at the Central Bank on behalf of their retail and institutional clients. Once a price is agreed to, the trade will be conducted via the Over-The-Counter (OTC) market and not via the regular market where the large majority of trades take place nowadays. Another change is that trading in the ‘QE window’ will close at 13.30 hours on the OTC market rather than at 12.30 pm on the regular market. There is also the possibility of negotiating deals until 14.30 hours but the actual trade will then be passed on the following day.

Despite the change in the trading ‘venue’ and the timing, settlement of executed trades will still take place in the normal procedure on a T+2 basis, i.e. two business days after the trading day.

The Central Bank also indicated that it will be making use of its right to amend its indicative price list during the course of its trading session. Currently, market participants and investors are accustomed to viewing the website of the Central Bank at around 10.30 hours to obtain the indicative bid prices at which the Central Bank is willing to buy and the offer prices in the few instances that they have some stock available for sale. The Central Bank explained that any changes to such indicative prices will be published by 11.45 hours and could reflect some QE trades conducted earlier on in the day. As such, market participants and investors need to constantly monitor such changes to keep abreast of movements in prices during the day. The OTC trades in the ‘QE window’ will not be visible on the website of the MSE. Instead, the ECB will be publishing the aggregate purchases of securities across the eurozone on a weekly basis.

Ever since the announcement in late January, many international analysts questioned whether the ECB will manage to implement its bond-buying programme given that in view of the relatively low level of risk of government paper, banks, pension funds and insurance companies opt to retain sovereign bonds in their portfolios in line with regulatory capital requirements. The question is more pertinent to Malta given the particular circumstances across the local financial system with most financial institutions already holding very high levels of liquidity and a large number of retail investors also struggling to find a suitable number of investment opportunities. This was exacerbated by the recent MGS issue where the size was insufficient to meet the extraordinary demand of €443 million and the Treasury will be refunding €260 million in the coming days.

Statistics indicate that 65% of all MGS are either held by retail investors or financial institutions (banks). So if retail investors and banks, who already have high amounts of liquidity and are also in the market to purchase MGS, who will be selling via the QE window? Moreover, a further 9% is held by resident insurance companies which, most probably, would also be unwilling to sell their current MGS holding as the alternative investment options at the prevailing low yields will further disrupt their asset-liability management functions.

In last week’s press conference by the ECB, it was revealed that the ECB will also accept to purchase securities with negative yields, so long as those yields are not below the ECB deposit rate at the time of purchase, which currently stands at -0.2%. Although since the initial announcement on 22 January, sovereign prices across the eurozone (including Malta) have continued to surge and yields tumbled, this latest aggressive stance by the ECB may indicate that prices may rise further during the initial phase of the QE programme. On the other hand, however, it is worth noting that the ECB stated that if any national central bank cannot purchase sufficient securities to fulfill its allocation, the ECB will allow substitute bond purchases in a specific list of a number of international and supernational institutions and agencies such as the Council of Europe Development Bank, the European Investment Bank, and various others. These substitute purchases should therefore enable the ECB to fill its €60 billion target each month across the eurozone. As such, local investors should not assume that the Central Bank will buy at all costs given the programme of €36 million per month. Moreover, it is also important to highlight that although €36 million per month may be initially viewed to be a large amount, an average value of €70 million per month traded across the MGS secondary market during 2014 and this increased to €82.7 million in January 2015 and a record of €143 million last month.

Further price gains from the additional demand coming to the market may well instigate certain retail investors to realise some of the extraordinary gains on their MGS holdings. However, many will question where to invest the resultant funds in order to generate the much-needed regular income stream to maintain their present living standards. Without adequate investment opportunities from the private sector (corporate bonds and also equities), many retail investors will possibly still be reluctant to dispose of their MGS irrespective of the price offered. Other investors may, on the other hand, view this as an opportunity to reduce their long-term MGS holdings before some of these gains start to fizzle out. This is likely to happen once the QE programme comes to an end. At a later stage, significant price drops can be expected from current levels especially in the longer-term securities once economic data begins to indicate that a recovery is gathering momentum as this would imply that interest rates will eventually start to rise. Although most international economists expect that such an eventual interest rate hike will not happen before 2019, bond prices normally react ahead of the event.

“…the ECB will allow substitute bond purchases in a specific list of a number of international and supernational institutions and agencies…”

The ‘wall of money’ which is very evident across the local financial system seeking a home and which may increase should investors utilize the ‘QE window’, provides an opportunity for the private sector to provide investment opportunities to the public at large via the listing of equity and bond instruments on the Malta Stock Exchange. In order to facilitate this process and instigate more public listings, some regulations may need to be reviewed such as the free float requirement, i.e. the percentage of shares held in public hands when companies are conducting an Initial Public Offering.

Given these unprecedented circumstances, market participants, regulators and other authorities need to openly discuss what measures are necessary to ensure a deeper capital market is in place that can fulfill the growing requirements of retail and institutional investors as well as support economic growth in Malta.

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Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.