Banque de France Bulletin no. 246: Article 1 French sovereign debt liquidity: main factors, recent developments and resilience during the Covid crisis

By Rossi Arthur, Lecomte Ernest, Legrand Théophile, Nguyen Benoît

Thematic: Financial stability and financial system

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For a debt instrument to be considered a safe asset, its liquidity must be preserved – it can be bought and sold without a loss – especially when interest rates fluctuate significantly. This article measures the liquidity of French sovereign debt by analysing the “free float” – the debt that can be traded on financial markets. It finds that the liquidity of sovereign securities with a lower free float declined more during the Covid crisis. The Eurosystem’s securities lending facility has helped to mitigate the scarcity effect created by the decline in free float since 2015. Moreover, during the period of liquidity stress that started to subside at the end of March 2020, liquidity deteriorated first in the repo market, then in the cash market and finally in the futures market. Nevertheless, in a global context where liquidity stress episodes are more frequent, French public debt remains one of the most liquid in Europe.

1 Structure of the French government bond market: main stakeholders and investors

Significant outstandings, underpinned by its issuer’s active management policy

French public debt issued on the markets is one of the most traded in the European Union (EU), due to its high outstanding amounts and issuance volumes – EUR 2,813 billion in the fourth quarter of 2021, i.e. 22% of the EU’s public debt – France’s high credit rating, and Agence France Trésor’s active debt management, based on the principles of consistency, predictability and transparency (Copin et al., 2022).

In order to meet the government’s financing needs and those of each class of investor (operational or regulatory constraints, type of management, performance requirements), AFT uses a wide range of instruments with maturities ranging from 12 weeks to 50 years. There are six such instruments: Treasury bills (BTFs) with a maturity of less than one year, fixed rate bonds (OATs and green OATs), inflation indexed bonds, or linkers (OATi, OAT€i, and green OAT€i). A seventh instrument can be traded since France authorized the stripping of its sovereign bonds in 1991 (STRIPS) – https://www.aft.gouv.fr/en/stripped-government-securities

AFT meets the demand stemming from investors that regularly seek to trade “off-the-run securities”, i.e. bonds that are traditionally less liquid as they started maturing and no longer represent the current market benchmark, by re issuing such bonds. These issuances improve the liquidity and depth of the 95 debt securities that have been issued by AFT. In 2020 for instance, 55% of issuances comprised benchmark securities, while 15% concerned new securities, and 30% replenished off the run securities. Moreover, AFT often buys back its short dated bonds (with typically a remaining term of up to two years), in order to smooth the volume of maturing bonds which are financed by long dated bonds when market demand for long term securities exceeds financing needs in a given year (see also annex B “Survey on Liquidity in Government Bond Secondary Markets”, OECD, 2022).

Liquid markets that attract significant volumes: cash, repo and futures markets

Market liquidity can be defined as the ability to buy and sell assets quickly (immediacy) with high trading volumes and numerous counterparties (depth and breadth) without substantially affecting the assets’ price (tightness or resilience). In terms of instruments, liquidity generally refers to assets that can be converted into cash quickly without a significant loss in value.

The liquidity of French tradeable debt is underpinned by large trading volumes on the cash, repo and futures markets…