Key Points

• 30 class actions have been filed in the US alleging manipulation of the auction facility used to issue new US Treasury securities.
• Fideres investigates these allegations and discusses if European government bond markets could be affected by similar misconduct.

Background

Recent weeks have seen approximately 30 class actions filed in the US alleging manipulation of the auction facility used to issue new US Treasury securities. The implications of these allegations are widespread and the parties damaged range from investors who sold Treasuries right through to the US Treasury and US taxpayers themselves. Fideres has conducted extensive quantitative analysis of these allegations and this research alert provides an overview of the allegations and our findings to date as well as considering whether or not similar activity could have taken place in Europe.

What Are the Allegations?

The current allegations are focused on the activity of the Treasury auctions’ primary dealers. Specifically, it is alleged that the primary dealers coordinated their auction bids¹ to obtain an artificially high yield on newly issued Treasury securities. This has the impact of increasing the coupon payable on these securities, thereby benefitting those purchasing the securities and increasing the funding costs of the US Treasury.

What Are Our Findings?

Fideres Found That:

1. Prices of Treasury securities and Treasury derivatives consistently fell in the time window leading up to the close of competitive auction bidding. This is equivalent to an increase of Treasury yields and, as highlighted in the chart above, is not matched on non-auction days;
2. The published auction yields of reissued Treasuries are higher than their traded yields in the secondary market in up to 75% of auctions;
3. The when-issued market, a key market for price discovery around Treasury auctions, consistently underestimates the published auction yield on newly issued Treasuries;
4. Dealers increase their exposure to Treasury securities during auctions without hedging their positions using derivatives. Such activity allows dealers to earn significant excess returns from the observed post-auction price reversal.

Could This Be Happening in Europe?

While the current allegations are limited to US Treasury auctions, there is nothing to suggest that similar behaviour could not be taking place in the markets for European Treasuries.

In fact, government bonds in the UK, Germany, Italy and France, to name but a few, are all issued via auction. Therefore, similar incentives may exist for bidders in these auctions.

As such, Fideres estimates that it may only be a matter of time before regulators in Europe open investigations into this matter.

¹ More information on the auction mechanism for issuing new US Treasury securities can be found HERE.