On Thursday, the Italian Treasury made a relatively interesting, if low-profile, announcement.
From now on, it said, it would begin issuing a new type of floating rate bond called a CCTs-eu. This was to replace conventional CCTs (Certificati di Credito del Tesoro) which were until now linked to the weighted average rate for six-month Italian BOT bonds.
The new floating-rate securities would be indexed to the six-month euribor.
And just in time too.
According Marc Ostwald of Monument Securities, conventional CCTs – being priced off BOTs – had become increasingly tricky to price versus normal Floating Rate Notes (FRNs) due to the multiple of rates to be considered when calculating their spread, among them Libor and Eonia.
As Ostwald explained to FT Alphaville:
…one has to incorporate assumptions on the Spread between BOTs and LIBOR, and because BOTs are priced over EONIA, in effect you have to forecast the BOT-EONIA spread and then look at the market pricing of Forward 6mth EONIA/LIBOR spreads.
A simplification of the process hence should make the paper more desirable to investors. So it shouldn’t be a surprise that some other eurozone countries have already embraced similar changes in their floating-rate issues.
As Unicredit observed on Friday, there are already Spanish, Greek and Belgian comparables in the market. As they wrote:
Italy was the only EMU country to issue floaters until 2007. As the market has become more and more competitive and issuers have faced the need to exploit demand in the most efficient ways, Belgium, Spain and Greece have started to issue FRN linked to the Euribor in the last two years.
However, none of these countries started a regular issuance program aimed at developing a liquid asset class. Spain issued EUR 5.3bn of SPGB Oct12 in2009 and EUR 1.5bn of SPGB Mar15 this year, both linked to the Euribor 3M. However, both issues are not part of a regular issuance program.
As a result, the liquidity of these instruments is not particularly high. Similarly, the lack of a complete curve reduces the possibility of relative value trades or arbitrage with the fixed-coupon curve. Belgium issued EUR 3bn of BGB May11 in 2007 and no other floaters afterwards. In contrast, Italy aims at creating a liquid asset class with a regular issuance program.
But, as Unicredit also state, Spain’s, Greece’s and Belgium’s issues never aimed to be part of a formal programme. They were simply one-offs. Only — Italy’s actually stands to become a liquid and stable asset class.
As they noted (FT Alphaville’s emphasis):
The decision to start issuing FRN linked to the Euribor is a very important and strategic one, and reflects the deep market changes which have occurred in the last few years. The Italian Treasury aims at progressively substituting CCTs with the Euribor linked notes. The current stock of CCTs amounts to EUR 150bn. About 10% of this amount will expiry in December. Additional 30% will expire in 2011.
Now, if you bear in mind what happened in the Eonia markets at the beginning of May, and consider that CCTs made up some 12 per cent of yearly funding for the Republic in 2007, it’s understandable why Italy should feel inclined to kick-start the amendments now.
CCTs after all came under severe pressure with the beginning of the subprime crisis, due to their higher exposure to short-term EMU rates.
As for what happened in May in the money markets that might prompt Italy to act as soon as June? This was the analysis from ECB’s latest monthly bulletin (emphasis FT Alphaville’s):
Developments in the money markets on 6-7 May suffered from contagion from the turmoil in sovereign debt markets, triggered by a sharp increase in uncertainty relating to counterparty risk. Liquidity also became scarce in the interbank money markets.
Liquidity in unsecured lending worsened not only in the case of term maturities, but also for the overnight market. This was indirectly reflected in lower volumes underlying the fixing of the EONIA, which averaged around €20 billion per day in early May (see Chart C).
Unsecured lending had been suffering since the collapse of Lehman Brothers, but trading in the shortest maturity segment (one week or less) had remained resilient until 5 May. The disruption of the functioning of the overnight market observed on 6-7 May was thus of particular concern. At the same time, access by euro area banks to US dollar funding also worsened. The costs of US dollar borrowing implied by foreign exchange swap quotations jumped significantly above the US dollar LIBOR of equivalent maturities.—–
Indeed, the probability of a simultaneous default of two or more euro area large and complex banking groups, as measured by the systemic risk indicator shown in Chart E, rose sharply on 7 May reaching values
higher than in the aftermath of the collapse of Lehman Brothers.1 Against this background, all commonly used measures of risk, such as the spreads of EURIBORlinked derivatives vis-à-vis EONIA swaps, or implied volatilities of interest rates, increased sharply (see Chart F). Access to market financing by banks across the euro area was seriously impaired.
Related links:
ECB debt certificates live on in analysts’ minds – FT Alphaville
What does weak demand for ECB funds mean? – FT Alphaville
Wake up and smell the BTPs – FT Alphaville