LONDON: The European Central Bank will begin buying corporate bonds at the end of this quarter, but many in the market believe it is still yet to nail down the full logistics of a scheme that is fraught with danger.
While the ECB has previously bought paper outside of the public sector bond market, through its covered bond and asset-backed securities programmes, these are far smaller markets, largely comprised of Triple A bonds rated that are often bought by central banks and bank treasuries anyway.
Corporate bonds, however, present a whole new frontier.
"It's a massive market, so they need to buy a vast amount of paper to have any impact," said one bond syndicate banker.
"Consequently, the risks of that process being less than optimally managed increase substantially."
The ECB's March announcement that it would buy investment-grade euro bonds issued by non-bank corporations was light on detail, with many expecting the central bank to provide more specifics on the so-called CSPP after Thursday's meeting of its governing council.
"Everyone's trying to work out how exactly is this going to work - and nobody knows," said Mark Wade, a senior partner at Rogge Global Partners.
"It looks as if the ECB, on the face of it, doesn't want to participate in primary. But the reality is that liquidity is so bad right now, it's difficult to see how they can't."
The Bank of England's corporate bond purchase programme demonstrated the limits of sourcing paper solely in the secondary market. Launched in April 2009, it made a lacklustre ?1.5bn of net corporate bond purchases by year-end.
In contrast, some analysts believe the ECB will look to buy 10bn-15bn of corporate bonds per month. A more conservative expectation from Bank of America Merrill Lynch credit strategists is still for 3bn-5bn a month.
They add that when the ECB launches the programme at the end of June, primary supply is expected to be "much more modest" than at the start of the year. And with the European bond markets largely shutting up shop in August, the programme might not hit its stride until September.
ALLOCATION DRAMA
Paul Suter, a fixed income trader at ECM Asset Management, said BAML's lower estimate could still be difficult to achieve even if the ECB buys in the primary market.
"There are limits on how much of a book you might want to allocate to one buyer - say 10%-15% - and also corporates might not want the ECB to be their biggest holder," he said.
"Companies ultimately get the final say on allocations."
The fairness of corporate bond allocations is one of the most hotly debated issues in capital markets today, even without the added complication of large ECB orders thrown into the mix.
Opinion is split on whether corporate treasurers will want to allocate large chunks of new bond deals to the central bank, although some may see the upside in having a big passive holder.
"The borrower will always give preference to the bondholder who buys to hold to maturity and who will pay the tightest spread, and the ECB will win on both of these points," said a second syndicate banker.
In the covered bond purchase programme, the ECB can own up to 70% for each ISIN, and several covered bond deals this year have seen more than half the paper placed with central banks.
Such chunky allocations would likely provoke uproar from corporate bond fund managers, particularly if they felt the ECB did not make considered credit decisions before placing orders.
BETTING AGAINST THE BANK?
The ECB originally appointed four executing asset managers to conduct its ABS purchase programme, which the first banker described as ECB officials recognising that they "were sufficiently out of their depth" to make credit decisions.
But he said adopting a similar approach for corporate bonds would be "much more difficult".
"ABS is a tiny market and asset managers could find ways to divide themselves into little compartments," he said. "Corporate bonds cover such a large part of an asset manager's business - I just don't know how they could do it."
ECM's Suter said that the ECB's selection criteria are likely to open up many issues.
"If they keep the buying programme in-house, what resources will be dedicated to research and credit analysis? Would they make decisions based on external ratings?" he asked.
"What would happen if a name they own gets downgraded below investment-grade like Casino or involved in a scandal like VW?"
Corporate bonds also have the added complexity of an adjacent credit default swap market, something not present in European asset-backed securities or covered bonds.
The BAML strategists note that for some names the ECB is expected to buy, bond and CDS prices have already "totally disconnected" since the March announcement.
The second banker agreed that the existence of CDS makes the scope for "wholesale market distortion" even greater.
"You have to ask: will we get into a position where people start speculating against central bank action, much like George Soros and the ERM?"
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