Demand for AAA Europe Collateral Pushes Bond Lending to Record Levels

(January 16, 2012)  —  Demand for high quality sovereign bonds to use as collateral has pushed the level of AAA-rated countries’ bonds out on loan to record levels as Europe continues to feel market tremors.

Triple A-rated Germany, the UK and until last week, France, have seen a record level of their government debt lent out by long-only investors so far this year, as other financial institutions scrambled for high quality collateral, according to market monitor Data Explorers.

The data provider said: “There was strong demand to borrow French, German and UK bonds which recorded utilisation levels of 42.1, 47.5 and 47.4% respectively.”

This ‘utilisation’ figure represents the amount of bonds that were borrowed having been made available for loan other market participants – usually long-only investors.

Data Explorers said: “This demand is no doubt driven by investors looking to use bonds as collateral in repo and other finance transactions. Overall there was a 1.7% increase in the European sovereign bond utilisation to 40.7%.”

As some countries in the Eurozone have suffered crises of confidence the quality of their debt has been questioned and the ever-larger haircut – or discount – demanded by counterparties taking it as collateral has meant borrowing it in large quantities has become inefficient.

The price of borrowing these securities has also rocketed. Greek and Portuguese bonds, which have the highest yields in of all Eurozone debt, are two of the most expensive European sovereign bonds to borrow.

One market participant told aiCIO: “There is exceptionally limited supply of this low-grade debt, so whatever there is costs a lot to borrow. “

However, he added that there was very little borrowing of Greek and Portuguese debt in the current market.

This week the European sovereign bond market appeared to shrug off last week’s downgrades with the majority of affected countries seeing their yields tighten by the  end of European trading – a sign of confidence in the market.