Cyprus to buy back existing bonds, replace them with new ones

First issue of Cyprus bonds through MTS by Q1 2008

 

The Cyprus government will proceed to buy back most existing local currency bonds ahead of the shift to the electronic auction and trading on the MTS platform, with the new bond issues to be made by the first quarter of 2008.

The Central Bank of Cyprus and the Ministry of Finance decided to launch an electronic trading platform (MTS) to conduct auctions in the primary market and the trading of government bonds and bills in the secondary market.

According to the Central Bank, the new market for government bonds and T-Bills will be called “MTS Cyprus” and will be part of the “EuroMTS” platform, which is the most established trading platform for government bonds in Europe. The government bonds will continue to trade on the CSE.

This development is a step towards the establishment of a modernised and widely used platform for the trading of bonds and T-Bills in Cyprus. In essence, the Central Bank and the Ministry of Finance have done a thorough restructuring of the bond market, with the objective of making it more competitive, transparent, liquid and easier to trade.

 

— Buyback

One of the Central Bank’s first steps is to buy back up to CYP 5 bln in Cyprus Republic debt that has been issued locally, excluding those issued to the Social Insurance Fund.

Of the total, at least CYP 2.6 bln are believed to be listed in the secondary market on the CSE.

As senior Central Bank officials explained to the Financial Mirror, the buyback scheme will involve the Central Bank working out a “fair valuation” of all outstanding bonds and price them to maturity, and in exchange either issue new bonds with the average duration of the old bonds, or settle in cash.

Thus a person holding various dated bonds with maturity of 3, 4 and 5 years would exchange for a 4-year new bond based on the fair valuation or receive cash. With the bulk of local government bonds held by banks, insurance companies, pension and provident funds, the central Bank hopes that the majority will see the benefit of the shift and go along. Those who insist to hold, will be able to do so, but will have difficulty to trade in the secondary market and will need to keep the bonds until maturity.

 

— Depository, clearing

The CSE will continue to act as the Depository for the Republic of Cyprus bonds and as clearing agent with the bonds to trade on the local stock exchange as well as on the MTS platform.

The CSE is now in the process of integrating new software to be able to communicate directly with the primary dealers and clear and maintain the trades also occurring on the MTS platform on the basis of a “delivery vs. payment” system on T+zero as per the dealings of the two parties or otherwise transaction date plus three working days, known as T+3.

 

— Primary dealers

The Central Bank is now in the process to select primary dealers who will have first right and obligation to buy the Republic of Cyprus bonds during the auction. The primary dealers will also be obliged to buy a certain percentage of bond issues at the auction and as trading starts on the MTS platform, make continuous bid/offer prices.

The role of primary dealers was approved through legislation passed by the House of Representatives in 2006.

Investors wishing to trade in Cyprus bonds will go through their normal channel of trading – banks, stock brokers – with the final orders channelled to the primary dealers for execution. In the secondary market, investors may also trade the bonds through the CSE.

Under the MiFID rules, in theory at least, both platforms (MTS and CSE) should inform prospective clients of the best quotes in the other market.

As for the spread, the Central Bank will fix the spread (agreed with the primary dealers) for each issue.

Other small European countries using the MTS platform model through primary dealers usually have appointed 6-10 primary dealers while large countries have a maximum of 15.

 

— Calendar of issues

At last, the Central Bank after consultations with the Finance Ministry will issue a calendar of forthcoming issues, allowing all participants to plan ahead, instead of the current chaotic system whereby the government turns to the local capital markets without prior notice or a timetable.

Once the main calendar is issued, say in conjunction with the budget, then it would undergo changes and adjustments every three months in line with government funding needs.

 

— No snub of CSE

Central Bank officials insist that by choosing the MTS platform they (and the Finance Ministry) have not undermined the CSE, which was keen to become the vehicle for primary auctions as well as secondary trading.

“We could hold the auctions, as we do now, through the telephone, or by fax or through a closed network with the primary dealers, which is essentially what we do now. But we chose to do the auction through the MTS platform, which is where the primary dealers are already based in order to make it cheaper, easier and less costly for them to transact with us. In any event, the auctions were never done through the CSE, so there is no issue of Central Bank or the Finance Ministry undermining the CSE,” a Central Bank official told the Financial Mirror.

The CSE had been lobbying hard to become the platform for government bonds with the objective of attracting institutional investors from abroad, who after becoming familiarised with Cyprus bonds, would also consider investing in local titles.

 

— Pricing premium?

Irrespective of how the bonds are auctioned, or which platform they trade on, the fundamental question is at what price or premium over comparative euro government bonds the Cyprus bonds will be issued and how big the spread will be.

Central Bank officials insist that the pricing or premium over German bunds (the benchmark in the euro-zone) will depend on the state of the Cyprus economy and the policies that successive governments adopt and implement.

If the ruling government decides to maintain budget deficits, then obviously the spread will increase, whereas if the government decides to run a budget surplus and maintain it, then obviously the premium will shrink and there will be more demand for Cyprus paper, which in the process also reduces the cost of borrowing for Cyprus.

As for pricing in the secondary market, the objective is that with the arrival of primary dealers, there will be bid/offer prices at reasonable spreads, allowing investors to buy or sell and trade in Cyprus bonds.

 

— New features

Currency: As with every commercial transaction, from January 1, 2008 all new bond issues will be in euros.

Coupon: The current system of making two interest payments will be scrapped and instead, interest will be paid once a year.

No halt: There will be no halt in trading for the bonds to trade ex-dividend or in essence ex-interest and there will be continuous trading in the bonds irrespective of when the interest is paid.

Minimum scrapped: The current minimum lot of CYP 1000 and minimum trade in CYP 100 multiple lots will be scrapped to 1 euro cent.

Repos: A new feature of the new system is that bondholders will have the option to engage in so-called repos (not to be confused with Central Bank repos done for monetary policy operations), which essentially means a bond holder may lend to others in exchange for other comparative bonds or against cash, with the promise to return, plus or minus the fees. Something like a swap. This is seen helping the secondary market trading and is a tool for people not to go short.