Session 4: Cross-Country Comparison 

of Drivers of Liquidity

Ignacio Fernández-Palomero

Head of Funding and Debt Management

June 2013
Liquidity in the Spanish Sovereign Debt Market

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 Difficult to pin down a single metric for liquidity: a combination of factors

 Ad hoc definition of secondary-market liquidity in Spain’s Government bond market:

“The willingness of market makers to commit to quoting and trading an adequate 

volume of bonds transparently, publicly and competitively”

 This definition helps us observe aspects of liquidity empirically, understand the determinants of

liquidity and identify the benefits of a liquid market.

 Trading and turnover of Government bonds

 We measure total turnover of bonds in electronic platforms, voice brokering and with final clients.

 Quoting in Electronic platforms

 Bid-offer spreads are a crucial variable, but not the only one.

 We also look at number of bonds quoted on the curve, volume quoted per bond and the number of

hours quoted under those conditions – all of these show willingness to provide liquidity

 Liquidity is a public good that should be rewarded in different ways. The Spanish Treasury

evaluates liquidity provision through various indices, and rewards it with non-comp rounds and with

occasional syndicated issuance.
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Liquidity in the Spanish Sovereign Debt Market

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 Trading turnover is the simplest metric to

observe long-term trends

 Liquidity has deteriorated since 2007

 Annual turnover fell from 80 times to 20

times outstanding debt

Turnover

(Total turnover relative to total outstanding debt)

Quoting Spreads of the 10yr Benchmark Bond 

(Percentage points of yield)  Bid-Offer quoted yields reflect mediumterm liquidity tensions

 Sharp deterioration in November 2011,

with LCH increasing Italian margins

 Substantial improvement with LTRO

auctions and OMT announcement
Liquidity in the Spanish Sovereign Debt Market

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 A composite index of quoting effort

 For each bond, a Primary Dealer obtains

a daily score which is a function of:

 Quoted spread (-)

 Volume quoted (+)

 Time quoted (+)

 This aggregate index is a good measure of

a trading desk’s willingness to provide

liquidity in volatile markets.

 Liquidity enables market access

 “Willingness to quote” is correlated...

 ...Positively with the average life of

the Treasury’s issuance

 ...Negatively with “tails” in primary

auctions (average – marginal yield)

 Causality: usually, better quoting and

trading encourage and improve issuance,

but a feedback loops are possible.

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Avg. Life (LHS) Quoting Index (RHS)

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Tail at Auctions (LHS) Quoting Index (RHS)

Average Life of Medium- and Long Term Issues 

vs Average Quoting Index

(LHS Avg. Life in years/RHS Smoothed Quoting Index)

Years

Quoting Index

Tail at Auctions (Average Yield-Marginal Yield)

vs Average Quoting Index

(LHS Tail in bps/RHS Smoothed Quoting Index)

Quoting Index

Tail in bps
Liquidity in the Spanish Sovereign Debt Market: Conclusions

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 Liquidity does not emerge naturally: it is encouraged or discouraged!

The issuer should incentivise competitive secondary-market liquidity

 Non-comp rounds for satisfactory quoting, none for poor quoting

 Secondary-market evaluation informs selection of benchmark syndicates

 Regular issuance in key tenors

 Availability of repo financing: Central Counterparties (CCPs) contribute to the public good of

liquidity and should therefore be actively supervised and regulated.

 Recent regulation affects the ability to warehouse bonds in long or short positions. Care should be

taken to balance two public goods: financial stability vs availability of liquidity

 Positive and negative feedback loops between liquidity and issuance

 Better liquidity generates investor demand in longer tenors, encourages Treasuries to issue

 Issuance in longer tenors generates the incentive for dealers to quote and trade the product

 Liquidity is a Public Good: a collective incentive to ensure it, a private incentive to free ride
Ignacio Fernández-Palomero 

Head of Funding and Debt Management

ifernandez@tesoro.mineco.es

Thank you for your attention

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