Hedge funds shake up the euro zone’s $10 trillion government bond market
thuram@euronews8.com
LONDON, March 19 (Reuters) – Hedge funds are piling into the euro zone’s $10 trillion government bond market, scenting opportunities as funding needs surge and the European Central Bank retreats.
The funds are buying a large share of government debt sales, providing a source of much-needed capital, traders and officials say. Yet the lightly-regulated investors often load their bets with bank debt, tying their fortunes to lenders, at a time when there is growing regulatory concern globally about their market impact.
Interviews with more than a dozen sources, including senior traders and treasury officials, as well as market data compiled exclusively for Reuters by electronic platform Tradeweb, show that hedge funds have become increasingly entrenched in the bloc’s debt market.
Hedge funds accounted for a record 55% of European government bond trading volume on Tradeweb last year, up from 36% in 2020, displacing other financial firms to become the dominant players for the first time.
And their reach was largest in some of Europe’s most indebted nations: hedge funds comprised two-thirds of trading volumes of Italian debt on Tradeweb, the data compiled for Reuters showed.
Tradeweb is one of the top three trading platforms for European government bonds, alongside Bloomberg and MTS, according to Coalition Greenwich, a financial services research company. The data includes euro zone countries and other European markets, including Britain.
Analysts at Barclays estimated in January the euro zone debt market needs to absorb a record 675 billion euros ($735 billion) of additional bonds this year as the ECB winds down its bond holdings. That comes as the pandemic and war in Ukraine have propelled government borrowing. Meanwhile, banks find their balance sheets constrained by rules introduced after the financial crisis of 2008.
Cue the hedge funds, lured by interest rates that have returned to positive territory after almost a decade.
Rapid growth in electronic trading in Europe, particularly since the pandemic broke out in 2020, has also lowered the costs of buying and selling securities, adding to the market’s allure. Electronic trading in the region has lagged the United States.
“These markets are very exciting and constructive to trade in,” Kenneth Tropin, founder of 30-year-old Graham Capital Management, which manages $18 billion in assets including government bonds, told Reuters. Graham is one of the longer-standing trend-following hedge funds.
Millennium and Citadel – two so-called multi-strategy funds that trade many different assets across a variety of strategies – and Haidar Capital together manage more than $120 billion and are among the most active hedge funds in the euro zone bond market, four of the traders and treasury officials said.
The three funds declined to comment for this story.
While hedge funds contribute to market liquidity, their increased presence strengthens the case for tightening their regulatory oversight, said Andreas Dombret, a former German central bank board member.
Banks typically have formal commitments as so-called ‘primary dealers’ to buy government bonds and to trade them actively in good times and bad, but hedge funds have no such obligations.
“They’re the first to leave the party if things get rough,” said Dombret, who now works as an adviser to banks including at consultancy Oliver Wyman.
Compared to the banking sector, the $3.5 trillion hedge fund industry is lightly regulated. It is comprised of private investment vehicles that do not report their profits publicly and do not disclose, sometimes even to their own investors, how they make money.
They speculate on asset prices rising as well as falling to make money for their clients, which include pension funds, sovereign wealth funds and rich individuals.
A spokesperson for ESMA, the European Union securities watchdog, declined to comment on growing hedge fund activity in the bloc. ESMA chair Verena Ross told Reuters on the sidelines of a conference that the regulator looks carefully at “particular funds” that build up leverage.
A spokesperson for the ECB told Reuters the central bank supports global efforts to boost regulations addressing investment funds and hedge funds.
