* German role as Europe's benchmark bond market seen at risk
* ECB bond-buying, regulation sapping volume
* France seen as an alternative benchmark
* German debt agency says doesn't take status for granted
* Gross supply in France and Germany: tmsnrt.rs/2ccQh6k
By Dhara Ranasinghe
LONDON, Sept 15 Germany's status as Europe's
benchmark government bond market is at risk as Berlin borrows
less and the European Central Bank presses ahead with its buying
spree, sapping the liquidity that helps to attract investors.
German yields are the euro zone's lowest at most maturities,
German bonds are the assets against which others are priced and
are obligatory in many fixed income portfolios.
The euro zone's strongest economy, Germany also boasts the
top triple-A status with all the main rating firms and has a
well developed futures market in which investors can shield
themselves against risk.
Perhaps key to its status, analysts say, is the ease with
which investors can buy and sell the bonds without distorting
prices. That essential liquidity is now in decline.
The problem is that the European Central Bank, based in
Frankfurt, draws more of the bonds it buys under its 1.7
trillion euro ($1.90 trillion) asset-purchase programme from
Germany than any other country in the single currency zone.
While this is unlikely to stop investors from using German
bonds for investment and hedging any time soon, it could
encourage them to seek alternatives such as the French bond
market, which offers size and depth as well as ample supply.
The risk for Germany of losing benchmark status is that its
borrowing costs rise. With much of the German yield curve in
negative territory, investors effectively pay Germany to lend it
money. France pays investors 0.25 percent to borrow money over
Annual bond trading volumes are down more than 30 percent
since 2006 at around 4.7 trillion euros at the end of 2015,
German debt management agency data shows.
The market's turnover rate, a measure of buying and selling
in the secondary market as a proportion of total debt
outstanding, has halved over the last decade.
"For a benchmark market to serve its purpose, it has to have
depth; people have to be able to hedge and these characteristics
are disappearing from German Bunds," said Bert Lourenco, head of
EMEA rates research at HSBC.
He said a combination of central bank buying, part of
efforts to revive the eurozone economy, and regulation over the
past few years has had a similar impact to 15 years of
quantitative easing on the Japanese government bond market.
"That's the real problem -- what's taken 15 years in Japan
has taken 2-3 years in the euro zone," he said.
Declining market turnover, fewer participants and the
occasional violent price swings in Japan's bond market could be
harbingers of what is to come in Germany.
Last year's "Bund tantrum", during which 10-year yields
spiked sharply and quickly, caught investors off guard and
highlighted how volatile the German market has become.
Last year was the most volatile for Bunds -- long-dated
German bonds -- since 2011. The average daily move between the
highest and lowest price for Bund futures was about 86 ticks.
A sell-off in recent days has served as a reminder of how
quickly the market can turn.
Joerg Mueller, spokesman for the German debt management
agency, or Finanzagentur, said he did not believe Germany's
benchmark bond status was at risk, with liquidity in the
secondary and futures markets and its quality as an issuer
helping to underpin the position.
"We don't take our benchmark position for granted," Mueller
said. "We will continue to adapt to changes in our market
environment in order to defend that position."
ECB bond buying is clearly having an impact. With purchases
in proportion to each country's shareholding in the bank, the
ECB buys an estimated 20 billion euros of German bonds each
month, compared with about 15 billion in France and about 13
billion in Italy.
The ECB says it takes care not to disrupt the smooth
functioning of markets but some analysts say that is hard to
"They don't want to distort them too much but it is clear
that the ongoing bond buying is distorting markets," said
Patrick O'Donnell, an investment manager at Aberdeen Asset
The impact on trading volumes is exacerbated by falling bond
issuance, with Germany running a budget surplus since 2014 and
so not needing to borrow as much.
"In terms of a well-functioning bond market, it would be
nice to have a deficit in Germany," said Commerzbank rates
strategist David Schnautz.
Declining gross bond issuance in Germany contrasts with
rising issuance in France and is one reason why some investors
see French bonds as potential alternative benchmarks.
France also has a liquid futures market that can be used for
hedging -- OAT futures, alongside Bund futures, are among the
most actively traded contracts on the Eurex exchange.
"France's bond market may be a better alternative to Germany
as it is larger, has active futures contracts in the 5 and
10-year maturity points, a well-established nominal and linker
curve, and a transparent issuance programme," said HSBC's
Lourenco. Linker is the term for index-linked bonds.
However, other analysts believe the impact of QE, if
prolonged, will eventually undermine liquidity in other major
euro zone markets.
"While these markets have not really suffered the same
squeeze as Bunds, ultimately if QE carries on, it will filter
through to these markets too," said Rabbani Wahhab, senior fixed
income portfolio manager at London and Capital.
($1 = 0.8950 euros)
(Additional reporting by Michelle Martin in Berlin; Editing by
Nigel Stephenson and Keith Weir)