Quarterly Bulletin 2017 Q3

© Bank of England 2017ISSN 2399-4568

Topical articleCorporate Bond Purchase Scheme: design, operation and impact

170 Quarterly Bulletin 2017 Q3

Corporate Bond Purchase Scheme: design, operation and impactBy Thomas Belsham and Alex Rattan of the Bank’s Macro Financial Analysis Division and Rebecca Maher of the Bank’s Sterling Markets Division.(1)

• InAugust2016theBankofEngland’sMonetaryPolicyCommitteevotedforapackageofmeasurestosupportgrowthandreturninflationtotarget.Themeasuresincludedthepurchase,viatheCorporateBondPurchaseScheme(CBPS),ofupto£10billionofsterling-denominatedcorporatebonds.

• ThedesignoftheCBPSwasdrivenbyconsiderationsofmarketstructureandtheultimateaimofimpartingbroadmacroeconomicstimulus.TheCBPSdepartedfrompastassetpurchaseprogrammesalonganumberofkeydimensions,includingthesizeofallocationsandauctionpricing.

• TheSchemeappearstohavehadapositiveimpactonthesterlingcorporatebondmarket,promptingasharpdeclineincorporatebondspreadsonthedayoftheannouncementandariseinissuanceinthemonthsthatfollowed.

Overview

On4August2016,followingtheUnitedKingdom’svotetoleavetheEuropeanUnion,theBankofEngland’sMonetaryPolicyCommittee(MPC)announcedapackageofmeasuresdesignedtoprovideadditionalsupporttogrowthandtoachieveasustainablereturnofinflationtotheMPC’s2%target.Theannouncedsetofmeasuresincludedthepurchase,viatheCorporateBondPurchaseScheme(CBPS),ofupto£10billionofsterling-denominatedcorporatebondsoveran18-monthperiod.

ThepurposeoftheSchemewastoimpartmonetarystimulusbyloweringtheyieldsoncorporatebonds,therebyreducingthecostofborrowingforcompaniesdirectly.Itwasalsoexpectedtoinducethesellersofcorporatebondstoreplacethoseassetswithotherriskyassets,andultimatelyleadtoageneralrebalancingofinvestors’portfolios.Anditwasexpectedtostimulatenewissuanceofsterlingcorporatebonds.

ThedesignoftheCBPS,intermsofthesizeandpaceoftheprogramme,aswellastheapproachtoauctionsandthedegreeofdisclosure,wasshapedinlargepartbytheparticularcharacteristicsofthesterlinginvestment-gradecorporatebondmarket.CarefulconsiderationwasalsogiventotheparticularbusinessesthatshouldbeeligiblefortheScheme,withtheBankseekingtopurchaseonlybondsissuedbyfirmsthatmakeamaterialcontributiontoeconomicactivityintheUnitedKingdom.Andpurchaseswereallocatedacrossindustriesinawaythatwasintendedtoavoidcreatinganydistortionsintherelativeborrowingcostsfacedbycompaniesindifferentsectors.

Sterling-denominatedinvestment-gradeprivatenon-financialcorporate(PNFC)bondspreadsfell10basispointsonthedayoftheannouncementoftheCBPS,andaroundafurther10basispointsinthedaysthatfollowed.IssuanceinsterlingbyUKPNFCspickedupsharplyaftertheannouncement,withthehighestrecordedmonthlyissuanceofsterling-denominatedinvestment-gradebondsinSeptemberofthatyear.Marketintelligencealsosuggeststhattherewasanimprovementinliquidityinthesterlingcorporatebondmarket.

Thereisuncertaintyaboutthesizeofeachoftheseeffects,buttheavailableevidencesuggeststhattheCBPShashadapositiveimpactonthesterlingcorporatebondmarketandreducedthecostofborrowingforUKPNFCs.However,itisstilltooearlytoassessfullythetransmissionoftheCBPStotherealeconomy.

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Source:BankofAmericaMerrillLynch.

(1) TheauthorswouldliketothankCharlotteBarton,AmberEvans,RichardGordon,NickGovier,RyanMurphyandSrdanTatomirfortheirhelpinproducingthisarticle.

Topical articles Corporate Bond Purchase Scheme 171

On4August2016,followingtheUnitedKingdom’svotetoleavetheEuropeanUnion,theBankofEngland’sMonetaryPolicyCommittee(MPC)announcedapackageofmeasuresdesignedtoprovideadditionalsupporttogrowthandtoachieveasustainablereturnofinflationtotheMPC’s2%target.Theannouncedsetofmeasurescompriseda25basispointcutinBankRateto0.25%;anewTermFundingSchemetoreinforcethepass-throughofthecutinBankRate;anexpansionoftheassetpurchaseschemeforUKgovernmentbondsof£60billion;andthepurchaseofupto£10billionofsterling-denominatedcorporatebondsoveran18-monthperiod.(1)

Thisarticlelooksatthatlatterpolicy—theCorporateBondPurchaseScheme(CBPS).TheCBPSwasintendedtoworkbyimpartingbroadmonetarystimulus.ThatisincontrasttotheCorporateBondSecondaryMarketScheme(CBSMS)announcedin2009,whichwasprimarilyintendedtoeasecreditconditionsinthecorporatebondmarketbyactingasa‘marketmakeroflastresort’—providingliquiditybybuyingassetsintheeventthatprivateinvestorsbecameunwillingtotransact.(2)

Thefirstsectionbelowsummariseshowcorporatebondpurchaseswereexpectedtoinfluencefinancialmarkets—andultimatelyfeedthroughtotherealeconomy.ThebulkofthearticlethenlooksindetailatthedesignoftheCBPS,andconsidershowthestructureofthecorporatebondmarketinfluencedtheoperationalapproachtopurchases(Section2).ThefinalsectionexaminestheevidenceforhowtheSchemehasaffectedfinancialmarketssinceitsannouncementandimplementation.

Section 1: Transmission of corporate bond purchases to financial markets

Corporatebondpurchaseschemesarearelativelynewinnovation,withthoseofboththeBankofEngland,andtheEuropeanCentralBank,introducedin2016.Assuch,thereisnotyetanextensiveliteratureonhowtheywork.Butcorporatebondpurchasesarelikelytooperatethroughmanyofthesamechannelsasgiltpurchases,andsorepresentacomplementtosuchprogrammes.Thesechannelsaresummarisedbrieflybelow.(3)

Thefirstchannelisviasignallingaboutthefuturestanceofpolicy.Theannouncementofanyformofstimulusrevealsinformationtoeconomicagentsaboutthelikelypathofmonetarypolicy.Theadditionofanewpolicytoolmightalsoprovideinformationabouttherangeofmeasuresavailabletothepolicymaker.Second,policyactiontakenviaassetpurchases,aswithanypolicymeasure,helpssupportconfidenceamongagentsinthewidereconomy.Third,portfolio rebalancingbyinvestorsthathavesoldassetstothe

centralbank—andwhich,inturn,investthemoneyreceivedinsimilar,alternativeassets—willpushupthepricesofabroadrangeoffinancialinstruments.

Inthisway,itwasexpectedthatpurchasesofcorporatebondswouldcauseanincreaseintheprices(andsoafallincorporateborrowingcosts)ofbotheligibleandineligiblebonds.Assuch,itwasexpectedultimatelytobenefitsterlingcorporatebondissuersingeneral,ratherthanonlythoseeligiblefortheScheme(discussionoftheeligibilitycriteriafollowsinSection2).

Moreover,intheAugust2016MonetaryPolicySummaryandMinutes,theMPCstatedthat‘purchasesofcorporatebondscouldprovidesomewhatmorestimulusthanthesameamountofgiltpurchases’.Thatviewreflectedthreemainfactors.

First,corporatebondsarehigher-yieldinginstrumentsthangovernmentbonds,andsoarelessclosesubstitutesformoney.Asaresult,itisarguablythecasethatinvestorssellingcorporatebondstothecentralbankshouldbemorelikelytoinvestthemoneyreceivedinexchangeforthosebondsintoothercorporateassets,comparedwithinvestorsthatsellgiltstothecentralbank.Thistendstoimplyalargerportfoliorebalancingeffectfrompurchasesofcorporatebonds,comparedwithpurchasesofgilts,andsoalargerboosttothepricesofriskierfinancialassets—andassociatedwealtheffects.

Second,thesterlingcorporatebondmarketisratherlessliquidthanthemarketforgilts.Thepresenceofthecentralbankinthesterlingcorporatebondmarketwillprovideconfidencetodealersregardingtheirabilitytoexittradesinfuturewithoutundulyaffectingtheprevailingmarketprice,therebyimprovingthemarket’sfunctioning.Centralbankpurchaseswillalsotendtostimulateactivityinthesecondarymarket,byinducingportfoliorebalancingflows.Byimprovingliquidity,centralbankpurchasesshouldpushdownonthepremiumthatinvestorsdemandforholdingsterling-denominatedcorporatebonds,overandabovethecompensationneededtocovercreditrisk.

Andthird,purchaseswereexpectedtostimulateissuanceinthesterlingcorporatebondmarketsandsupportinvestment.Totheextentthatcorporatebondsaretypicallyissuedbylargercompanies,itwasalsothoughtthatashifttowardsissuanceofcorporatebondsandawayfrombanklendingbysuchcompanieshadthepotentialtoincreasetheamountofbankfundingavailabletosmallerones.

(1) Seewww.bankofengland.co.uk/publications/Documents/inflationreport/2016/aug.pdf.(2) ForfurtherinformationontheCBSMSseewww.bankofengland.co.uk/markets/Pages/

apf/corporatebond/default.aspx.(3) Afulldescriptionofthetransmissionofcentralbankassetpurchasescanbefoundin

Joyce,TongandWoods(2011).

172 Quarterly Bulletin 2017 Q3

Ofcourse,firmsmightusetheadditionalborrowingsarisingasaresultoftheCBPSforreasonsotherthaninvestment.Butmanyoftheseuseswillalsohelptosupporteconomicactivity.Forexample,firmsmightchoosetouseanimprovementinfundingconditionsasanopportunitytorefinanceexistingdebtatlowerinterestrates.Thiswouldincreasecorporateprofitability,andmightencourageinvestmentindirectly.Or,businessesmightchoosetoreturnmoneytoshareholdersthroughsharebuybacksordividends,andsoprovideaboosttohouseholdspending.

Section 2: Design and operation of the CBPS

TheCBPSwasdesignedtoimpartbroadstimulustothemacroeconomywhilealsoensuringthatitdidnotdistortthesterlingcorporatebondmarket,orcreateanyunfairbiastowardsparticularissuersorsectors.Hereweexplainhowtheseconsiderations,andthenatureofthesterlingcorporatebondmarket,influencedoperationaldecisionsregardingeligibilitycriteria,thesizeandpaceofpurchases,auctiondesign,sectorallocationsandthedegreeoftransparency.

WealsodescribehowthedesignoftheCBPSauctionprocessdifferedfromtheBank’sgiltpurchaseprogramme.Appropriateauctiondesigndependsonthenatureofthegoodsbeingpurchasedandthestructureofthemarket.Inbothoftheserespects,theCBPSdifferedfrompurchasesofgilts,giventhatthesterlinginvestment-gradecorporatebondmarketisbothmoreheterogeneousandlessliquidthanthegiltmarket.

Corporate bond eligibilityTheCBPSwasintendedtolowertheborrowingcostsandsupportbondissuanceoffirmsthatmakeamaterialcontributiontotheUKeconomy.Anevidence-basedapproachwastakentodeterminingwhetherissuersmadeamaterialcontributiontotheUKeconomy,witharangeoffactorstakenintoaccount.TheseincludedwhethercompaniesemployedsignificantnumbersofpeopleintheUnitedKingdom;whethertheygeneratedsignificantrevenuesintheUnitedKingdom;whetherbusinesseswereheadquartered,orhadanumberofoperatingsites,intheUnitedKingdom;oriftheyservedasignificantnumberofcustomersintheUnitedKingdom.TheassessmentofthematerialityofthecontributiontotheeconomymadebyindividualbusinessesisconductedbytheBank’sriskmanagementarea.

Theriskmanagementareaisalsoresponsibleforcreditriskassessment.Whenmakingajudgementaboutcreditrisk,arangeoffactorsaretakenintoaccount,includingtheratinggiventoborrowersbythecreditratingagencies,withonlyinvestment-gradecorporationsconsideredfortheScheme.Investment-gradefirmsarethosethatarejudgedtobeofatleastacertainminimumcreditqualitybyindependentrating

agencies.Thishelpedtominimisetheriskofmateriallossesduetodefault.(1)Corporatebondsissuedbybanks,buildingsocieties,insurancecompaniesandotherfinancialsectorentitiesregulatedbytheBankofEnglandortheFinancialConductAuthoritywerenoteligible.(2)Marketparticipantswereencouragedtosubmitsuggestionsforinclusionontheeligiblebondlist,whichwasreviewedonanongoingbasiswhilepurchaseswereunderway.

Size and pace of purchasesThereisaround£500billionworthofoutstandingsterling-denominatedinvestment-gradeprivatenon-financialcorporate(PNFC)bondsinissue,comparedwithoutstandinggiltissuanceofaround£2,000billion(Figure 1).Thesmallersizeofthecorporatebondmarket,aswellastherelativelyinfrequentlytradednatureofthoseinstruments,meantthattherewasrathermoreuncertaintyregardingthesizeandpaceofpurchasesthaninthecaseofgiltpurchases.

Therefore,theMPCtookthedecisiontobuy‘upto£10billion’(3)ofcorporatebonds,whichequatestoaround5%oftheeligiblestockofbonds(Figure 1).Forcomparison,theMPC’sannouncedgiltpurchasesof£435billionareequivalenttoaroundonethirdoftheeligibleuniverseofgovernmentbonds.TheMPCalsodeterminedthatpurchasescouldtakeplaceifnecessaryoverarelativelyextendedperiod,ofupto18months.

Inaddition,thesizeofindividualpurchaseoperationswasdesignedtobeflexible,adjustingautomaticallytoreflectthequantityandqualityoftheoffersreceived.Thismeantthatthepurchasepacecouldfluctuatetoaccountforseasonalityandmarketconditions.Forcontext,inthesterlingcorporatebondmarketthetypicaltradesizeisbetween£2millionand£5millionandtheretendstobeafairlywiderangebetweenthepricesthatmarketparticipantsquoteforbuyingandsellingagivenbond.Inthegiltmarkettypicaltradesizesarearound£50millionandthespreadbetweenbuyingandsellingpricesisaroundatwentiethofthatinthesterlingcorporatebondmarket.

Theflexibleauctiondesignwasincontrasttotheapproachusedforgiltpurchases,inwhichallocationsarefixedinsizeandannouncedinadvance.Variationinauctionsizeisevidentintheweeklyholdingsdata.(4)Weeklypurchasesvariedfrom£165million(excludingpurchasesinthefinalweek,inwhichthequantityofpurchaseswasconstrainedbytheclose

(1) TheCBPSformspartoftheAssetPurchaseFacilityandassuchitisindemnifiedbyHMTreasury.ForfurtherinformationontheAssetPurchaseFacilityseewww.bankofengland.co.uk/markets/Pages/apf/default.aspx.

(2) AtthesametimethattheCBPSwasannounced,theTermFundingScheme(TFS)wasintroduced.Thisprogrammewasdirectedatbanksandbuildingsocieties.ForfurtherinformationontheTFSseewww.bankofengland.co.uk/markets/Pages/apf/termfunding/default.aspx.

(3) The£10billiontargetisintermsoftheamountsspent,ratherthanthecurrentmarketvalue.

(4)Note,holdingsdatawerepublishedonaweeklybasisandthereforedonotshowthevariationperauction,butratherperweek.

Topical articles Corporate Bond Purchase Scheme 173

proximitytothe£10billionlimit)to£535million,withaverageweeklypurchasesof£357million.

Auction designPurchasesofcorporatebondsweremadeviareverseauctions,thesameapproachasisusedforpurchasesofgilts.(1)Auctionsfacilitatewideparticipationamongmarketparticipants.Andbydeterminingallocationsaccordingsolelytothemostcompetitiveprice,acrossarangeofsecurities,auctionshelptoavoidtheneedfortheBanktodiscriminatebetweencounterpartiesorinstruments.

Thepricepaidforeachsecuritywasdeterminedusinga‘uniform’pricingmechanism.Underuniformpricing,allsuccessfuloffersforabondareallocatedatasingle‘clearingprice’,whichisequaltothehighestacceptedpriceforthatbond.TheBank’sviewwasthatthisapproachwasappropriateforcorporatebonds,giventheheterogeneous,illiquidnatureoftheinstruments,andassociatedchallengesingaugingthemarketpriceforless-informedmarketparticipants.Byallowinginvestorstofocusononlythepricethattheywouldaccept,itwashopedthatuniformpricingwouldencourageparticipation.(2)

Incontrast,forgiltpurchases,theBankemploysa‘discriminatory’pricingmechanism.Underdiscriminatorypricing,eachsuccessfulsellerispaidtheirownofferprice.Thisisconsideredappropriateforgiltpurchases,giventhehomogeneous,liquidnatureoftheseinstruments,whichmakesitrelativelystraightforwardformarketparticipantstojudgethemarketprice.

Finally,totrytoensurethattheBankdidnotpayanymorethanwasnecessarytomeetitsobjectiveofpurchasing£10billionofcorporatebonds,theCBPSsetamaximumprice,abovewhicheachspecificbondwouldnotbebought.Arangeofsourcesofinformation—includingvariousmarket-basedindicatorsandinternalmodels—wereusedtodeterminethemaximumprice.Andthiscouldbeusedtocontrolthecompositionoftheportfolio,asdescribedbelow.

The sector keyAkeyconsiderationfortheMPCwashowtoensurethattheSchemewouldbe‘marketneutral’—avoidingfavouringsomefirmsmorethanothers.The‘sectorkey’wasthemechanismusedtoachievethis.ThesectorkeyshowstheproportionoftotaloutstandingeligibleissuanceaccountedforbyeachsectorintheUKeconomy.Purchasesweretargetedtomatchthoseproportionsbysector.Forexample,iftheelectricitysectoraccountedfor19%oftotaleligiblebondsinissue,theCBPSaimedtohave19%ofitsfinalportfolioallocationintheelectricitysector.

Reflectingtheflexibilityoftheauctions,thereweredeviationsfromthesectorkeyovertime.Inresponsetothosedeviations,theBankadjustedthepricesitwaspreparedtopayforagivenbondtoslowthepaceofpurchasesinsomesectors,whilespeedingitupinothers,andsomovethesector

(1) Ina‘reverseauction’participantssubmitoffersatwhichtheywouldbepreparedtosellspecificassets,ratherthansubmitbidstobuyspecificassets,ashappensinatypicalauction.Theoffersthatareacceptedaretheonessubmittedatthelowestprice(highestyield,inthecontextofbondpricing).

(2) Auctiontheorysuggeststhatuniformanddiscriminatorypricingareequivalentinrevenuetermssubjecttocertainconditions.Forexample,seeArchibald,FlynnandMalvey(1995).

Marketsize(c)

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Figure 1 Key features of the sterling corporate bond and gilt markets and associated purchase programmes

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(a) Marketsizedefinedasthemarketvalueofallsterling-denominatedinvestment-gradePNFCbondsinissue,asat11September2017.(b) Eligibleuniversesizedefinedasthemarketvalueofalloutstandingeligiblebonds,asat31August2017.(c) Marketsizeandeligibleuniverseareroundedtothenearest£100billion.(d)Marketsizedefinedasthemarketvalueofallconventionalandindex-linkedgiltsinissue,asat31August2017.(e) Eligibleuniversesizedefinedasthemarketvalueofalloutstandingconventionalgiltswithamaturitygreaterthanthreeyears,asat31August2017.(f) SeeSalmon(2017).(g) Averageissuesizeforgiltsdefinedasaveragenominalamountoutstandingpergiltforallconventionalandindex-linkedgiltsinissueasat30August2017.Averageissuesizeforsterling-denominatedinvestment-grade

PNFCbondsdefinedasaveragenominalamountoutstandingperbondasat11September2017.

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174 Quarterly Bulletin 2017 Q3

allocationsbacktowardthesectorkey.MaximumpriceswereusedtohelptheCBPSremainwithinrisklimitssetonholdingsofspecificbonds,issuersandsectors.IftheBank’sholdingswereapproachingitstolerancesregardingexposuretoaparticularbondorissuer,ordeviationfromthesectorkey,themaximumpricefortherelevantbondswouldbereducedtomakeitlesslikelythattheBankwouldpurchasethosebonds.

TransparencyForgiltpurchases,theBankpublishesdetailsoftheindividualgiltspurchased,includingtotaloffersreceivedandaccepted,aswellasthehighestandlowestacceptedprices.Incontrast,fortheCBPS,theBankpublishedweeklydataontotalcorporatebondholdings,withaone-weeklag,andamonthlyupdateofsectorallocationsrelativetothesectorkey.Asof3August2017,theBankpublishesupdateddataontheaggregatetotalstockofpurchasedcorporatebondsonamonthlybasis.(1)

Thedecisiononthedegreeofdisclosurewasfinelybalanced.Ultimately,itwasthoughtthatbydisclosinglessinformation,theBankwouldreducemarketdistortionsthatmighthavearisenasaresultofthepublicationofinformationonindividualbondpricingandallocations.Moreover,itwasthoughtpossiblethatthepublicationofthepricespaidinauctionsmighteffectivelyrendertheBankapricesetter.ThiswouldhaveruncountertotheintentionthattheCBPSrespondtomarketconditions,actingasapricetaker.Itwas,however,recognisedatthedesignstagethatthelowerleveloftransparencyalsocarriedariskofreducingparticipationintheScheme.

ToprovidefurthertransparencyontheBank’sholdings,eachmonththeBankpublishedthedeviationofitsholdingsfromthesectorkey.(2)Thiswasintendedtoguideinvestors’expectationsaboutthesectorsinwhichfuturepurchaseswerelikelytobeconcentrated.InsectorswheretheBankwasoverweight,itcouldbeassumedthatpurchaseswouldneedtoslow,whilethepurchasepaceinunderweightsectorswouldneedtoincrease.Inturn,itwashopedthatthiswouldinduceinvestorstosubmitrelativelymorebondstoauctionsforsectorsinwhichtheCBPSwasunderweight,therebyenablingtheBanktomovebacktowardthesectorkey.

CBPS reinvestmentCBPSpurchasesreachedthe£10billiontargetinApril2017.Sincethen,ateachofitspolicymeetingstheMPChasvoted,andwillcontinuetovote,onwhethertomaintainthestockofpurchasesat£10billion.Atitsmeetingending2August2017,theMPCvotedtomaintainthestockofcorporatebondpurchasesat£10billionandagreedthatitwouldreinvestcashflowsfrommaturingassetsheldundertheCBPSbackintoeligiblecorporatebonds.

Suchreinvestmentsareexpectedtobeginoncethefundsfromredemptionsreachsufficientsizetoallowanauctionprogrammetobeconducted.Basedonthecurrentprofileoftheportfolio,itisanticipatedthatthefirstsuchauctionwilltakeplaceinthesecondhalfof2019.(3)Thereafter,theprecisetimingsofthereinvestmentschedulewillbegovernedbythematurityprofileandcompositionoftheportfolio.Theboxonpage175providesfurtherdetailsonthecompositionoftheCBPSportfolioandtheimplicationsforreinvestmentoperations.

Section 3: Impact of the CBPS

ItisnotstraightforwardtoseparatetheimpactoftheCBPSonfinancialmarketsfromtheoveralleffectofthepackageofmeasuresannouncedon4August2016.Buttheinclusionofacorporatebondpurchaseprogrammewithinthepackagedidcomeasasurprisetomostmarketparticipants.SoitseemsreasonabletosupposethatmuchofthereactioninthecorporatebondmarketreflectedtheannouncementoftheCBPSinparticular.

Inthefollowingsectionwelookattheimpactofthepolicyannouncementonspreads,alongwithseveralothereventsassociatedwiththeimplementationoftheCBPS,thatallowssometentativeinferencestobedrawnaboutitstransmission.WethenattempttoidentifyhowmuchofthechangeincorporatebondspreadsfollowingtheannouncementcanbeexplainedbytheCBPSalone.WealsoconsidertheimpactoftheSchemeoncorporatebondissuanceandmarketfunctioning.ItisstilltooearlytoassessfullythetransmissionoftheCBPStotherealeconomy.

Event studiesAnnouncementeffectThereareanumberofeventsthatwecanlookattoassessthefinancialmarketimpactoftheCBPS.Togaugetheinitialannouncementeffect,wefirstlookatthefallinthestandardBankofAmericaMerrillLynch(BoAML)indexofsterling-denominatedinvestment-gradePNFCbondspreads.ThestandardBoAMLindexfellby10basispointsonthedayoftheannouncementoftheCBPS,withafurtherdropofaroundanother10basispointsinthefewdaysthatfollowed(Chart 1).Equivalentdollarandeurospreadswerebroadlyunchangedoverthesameperiod.ThattendstopointtoasignificantrolefortheAugustpolicyannouncement.Sincethen,sterling-denominatedinvestment-gradePNFCbondspreadshavebeenrelativelystable.

(1) Marketnoticeof3August2017;www.bankofengland.co.uk/markets/Documents/marketnotice170803cbps.pdf.

(2) Seewww.bankofengland.co.uk/markets/Pages/apf/corporatebondpurchases/results.aspx.

(3)MonetaryPolicySummaryandMinutesoftheMonetaryPolicyCommitteemeetingendingon2August2017availableatwww.bankofengland.co.uk/publications/minutes/Documents/mpc/pdf/2017/aug.pdf.Marketnoticeof3August2017availableatwww.bankofengland.co.uk/markets/Documents/marketnotice170803cbps.pdf.

Topical articles Corporate Bond Purchase Scheme 175

The Bank’s CBPS portfolio

Maturity profileOnlyarelativelysmallamountoftheBank’sportfoliowillmatureinthenextfewyears(Chart A).Becauseofthesmallsizeofredemptionsasbondsmature,theproceedsfromanumberofredemptionswillbeaccumulated,andreinvestedonaperiodicbasisviaauctions.Thematurityprofileofexistingbondholdingssuggeststhatfrom2019,auctionswillbeconductedatleastannually.Duringperiodswhentherearelargeamountsofmaturingbonds—forexamplein2022—theBankwillholdmorefrequentauctions.Itisanticipatedthattypicallyauctionswillbeconductedoncetheproceedsfromredemptionsreachbetween£250million–£400million.

ThematurityprofileoftheBank’sportfoliowasnottargetedbytheauctiondesign,butitisbroadlyrepresentativeofthatoftheeligibleuniverseofbonds.TheBank’sportfoliohasaslightlylargerconcentrationofholdingsinthe5–10yearmaturitythantheeligiblelistofbonds,andaslightlylowerconcentrationoflonger-maturitybonds.

ThematurityprofileoftheBank’sportfoliowillchangeovertime,witheachreinvestment.Itmightalsobeinfluencedbycorporateactionsthatresultintherepurchaseofbondsbyissuers.SomebondsmightalsobecomeineligiblefortheCBPSduetocreditratingdowngrades,whichcouldresultinthoseinstrumentsbeingsoldforriskmanagementpurposes.

Sector allocationChart B showsmonthlydataonactualsectorholdingsandcomparesthemwiththesectorkey.Asmightbeexpected,therewasanotabledivergencebetweentheBank’sportfolioholdingsandthesectorkeyatthestartoftheScheme.Thiswasparticularlyevidentinthepropertyandfinancesector,whichwasunderrepresentedintheportfolioduringmostof

theScheme.ButastheSchemeprogressedandtheproportionofpurchasesbysectorwasadjustedviathesettingofmaximumprices,theCBPSportfolioreturnedtowardsthesectorkey.WhenCBPSpurchasesreached£10billion,theportfolioallocationexactlymatchedthesectorkeyineightoftheninebroadsectorsandwasjust1percentagepointbelowthesectorkeyintheremainingsector(water).

Credit ratingInadditiontomaturity,thecreditratingoftheBank’sportfoliohasbeenmonitoredsincetheCBPSbegan.Chart Cshowsthat,comparedwiththeeligibleuniverseofcorporatebonds,theBank’sportfolioismarginallyoverweightbondsratedBBB+toBBB-,andisunderweightAAAtoA.

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Sources:BankofEngland,BloombergandBankcalculations.

176 Quarterly Bulletin 2017 Q3

Factoringinthefallingovernmentbondyieldsoverthatperiod,theoverallfallinsterlingborrowingcostsforPNFCsfollowingtheannouncementofthepackagewasaround30basispoints.

ImpactoneligibleandineligiblebondsWecansplitthesterlinginvestment-gradeuniverseofbondsintothoseeligibleforpurchase,andthosethatareineligible,tolookforevidenceofportfoliorebalancingeffectswithinthesterlingcorporatebondmarket.Ifportfoliorebalancingisinevidence,onewouldexpectanyfallinspreadstobebroad-basedacrossallsterling-denominatedinvestment-gradebonds.And,indeed,thisiswhatwasobservedinthedaysfollowingtheannouncement,withafallinbotheligibleandineligiblebondspreadsoccurringveryquicklyaftertheevent(Chart 2).Consistentwiththat,therewassubsequentlyrelativelylittlefurtherreactiontothe

announcementofthespecificbondsthatwouldbeeligibleforpurchase(Chart 2).

Evidenceofportfoliorebalancingintoineligiblecorporateassetsisconsistentwiththeviewthatcorporatebondpurchasesmightbemoreeffective,poundforpound,thananequivalentamountofpurchasesofgilts.Thatsaid,itistooearlytoidentifyfullyanydifferentialreal-economyeffectsfromthischannel.

ReactiontothestartofactualpurchasesTherewaslimitedreactiontothestartofpurchases,withnocleardifferenceintheresponsesofeligibleversusineligiblebondspreads(Chart 2).Thatsuggestslittleroleforpurchasesthemselvesinpushingspreadsdownfurthereitherdirectlyorviaportfoliorebalancing.

Therewasalsonoobviousdifferenceinthebehaviourofeligibleandineligiblespreadsinresponsetothepublicationon6October2016oftheamountofpurchasesconductedduringthefirstweekofoperation(Chart 2).ThesedatashowedthattheBankhadbeenbuyingassetsthreetimesfasterthanimpliedbytheaveragerateofpurchasesrequiredtohitthetargetofupto£10billionover18months,andmighthavebeenexpectedtocausespreadstofall.

Thatsaid,marketintelligencegatheredatthetimesuggestedthatsomeinvestorsinterpretedthenewsonthepaceofpurchasesasinformationabouttheresponsivenessofthesupplyofbondstotheScheme,withtheimplicationthatinvestorsweremorewillingtosellassetstothecentralbankthanhadbeenthought.Thiswouldtendtopushupspreads,offsettingthepossibleeffectthatthenewsonpacemightotherwisehavehad.

Sincethenthespreadbetweeneligibleandineligiblebondshasnarrowedgradually(Chart 2).Thatcouldbetentativeevidenceofa‘flow’effectfromactualpurchases,pushingdownineligiblebondspreadsassellersofeligiblebondsreallocatefundstosimilarineligiblebonds.ButthestartofthetrendappearstopredatethestartoftheScheme,sosomeother,longer-run,drivermightbethecause.

Therewaslittlereactioninspreadsfollowingcompletionofpurchases(Chart 2),astheweeklypublicationofthestockofpurchasesallowedtheScheme’santicipatedcompletiontobecapturedinpricesaheadoftime.ThatisconsistentwithhowquicklytheeffectsofthepurchaseswerefirstpricedinfollowingtheannouncementoftheScheme.

Identifying the specific impact of the CBPSAsnotedabove,theCBPSwasannouncedalongsideseveralotherpolicymeasures,soitisunclearhowmuchofthe‘announcementeffect’of10–20basispointsshouldbeattributedtotheCBPSspecifically.Totrytogetasenseofthe

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Sources:BloombergandBankcalculations.

Topical articles Corporate Bond Purchase Scheme 177

specificimpactoftheCBPSonsterling-denominatedinvestment-gradePNFCbondspreads,herewetaketwoapproaches.First,weconductasimpleeventstudythatcomparestheone-daymoveinthesterling-denominatedinvestment-gradePNFCbondspreadsonallpastgiltpurchaseannouncementdays.Second,weemployamoresophisticatedeconometricapproach,usingapanelofsterling-denominatedcorporatebonds,toisolatetheparticulareffectoftheCBPS.

ControllingforthesizeofthesurpriseingiltpurchasesStartingwiththeeventstudy,wecanobtainanestimateofhowcorporatebondspreadsmighthavebeenexpectedtomoveinresponsetotheAugust2016announcementofadditionalgiltpurchases,bylookingatchangesinspreadsfollowingpastgiltpurchaseannouncements.Herewelookattheone-daychangeinsterling-denominatedinvestment-gradePNFCbondspreadsfollowingannouncementsaboutgiltpurchases.Becausesomeoftheseannouncementswereanticipated,wecontrolforthisbyfactoringinwhatwasexpectedbyanalystsaheadofthoseannouncements.Thisgivesusabettermeasureoftheactualpolicynews,or‘surprise’,onthedayoftheannouncementineachepisode.(1)

Chart 3showsthemovesinsterling-denominatedinvestment-gradePNFCbondspreadsagainstthesizeofthesurprise.Interestingly,wefindthatcorporatebondspreadshavegenerallynotreactedtonewsaboutgiltpurchasesinthepast,whetherwecontrolforthesizeofthesurpriseornot.Inlightofthat,thissimpleapproachsuggeststhatitmightbereasonabletoattributemuch,ifnotall,ofthe10basispointfallinspreadson4August2016totheCBPS.

EstimatingchangesintheexcessbondpremiumTakingamoresophisticatedapproach,wefollowtheworkofGilchristandZakrajšek(2012)andDeSantis(2016).First,weestimatethe‘excessbondpremium’.Thiscanbethoughtofasthatpartofthespreadthatisinexcessofwhatisstrictlyrequiredtocoverexpectedlossesfromdefault.Itiscomprisedoftwoparts.Thefirstisthecompensationrequiredbyinvestorsbecausetheyaretypically‘riskaverse’;theywouldpreferacertainoutcomeinsteadofagamblewiththesameprobability-weightedaveragepay-off.(2)Thesecondisthecompensationrequiredtocoverthepossibilitythattheinvestorwillnotbeabletorealisethefairvalueoftheassetbecausethemarketisilliquid.

OnemightexpecttheimpactoftheCBPStobeevidentintheexcessbondpremiumfortworeasons.First,ashighlightedinSection1,akeytransmissionchannelfortheCBPSwasthesupporttoconfidencegiventobothparticipantsinthesterlingcorporatebondmarketandagentsinthewidereconomy.Thatislikelytobereflectedinafallinriskaversion,andsoalowerexcessbondpremium.Andsecond,theCBPSaimedtoimprovetheliquidityofthesterlingcorporatebondmarket,alsopushingdownontheexcessbondpremium.

Weestimatetheexcessbondpremiumonaweeklybasis,basedonalargepanelofsterling-denominatedinvestment-gradePNFCbonds.Bylookingacrossalargepanelofbonds,wecanseparateoutthecomponentsofthespreadthatareduetodifferencesincreditrisk(thecompensationrequiredtocoverexpectedlossesfromdefault,whichisidentifiedusingthecreditratingandthevariabilityoftheshareprice)andtherest—whichwedefineastheexcessbondpremium.(3)AndwefindthattheexcessbondpremiumfellmateriallyfollowingtheannouncementoftheAugustpolicypackage(Chart 4).

InordertoidentifyhowmuchofthedeclineintheexcessbondpremiummightbeattributabletotheCBPS,wethenregressitonasetoffinancialvariables(includingtheoilprice,equityprices,andchangesinexpectedinterestrates)thatproxymacroeconomicconditions,todeterminehowmuchofthefallinthepremiumwasduetothosefactors,andhowmuchduetoother,unexplained,factors.WeattributethelattertotheCBPS.Usingthisapproach,wefindthattheCBPSaccountsformostofthedeclineinspreadsobservedintheweekfollowingtheannouncement(Chart 5).TheEuropeanCentralBankfoundasimilarresultinthecaseoftheCorporateSectorPurchaseProgramme.(4)

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Sources:BankofAmericaMerrillLynch,ThomsonReutersandBankcalculations.

(a) AsurprisehereisdefinedbythedifferencebetweentheannouncedsizeofassetpurchasesandtheexpectationofthosesurveyedbyReutersaheadofthepolicymeeting,asinJoyce,Lasaosa,StevensandTong(2011).

(b) Arangeisgivenforthesurpriseon4August2016becausethepoll-basedexpectationwasfor£33billionofadditionalpurchasestobeannouncedatthatpolicymeeting,withanadditiontothetotalstockof£65billionbyend-2017.ThatcompareswithanactualannouncementinAugust2016of£60billion–£70billion.

(1) AsurprisehereisdefinedbythedifferencebetweentheannouncedsizeofassetpurchasesandtheexpectationofthosesurveyedbyReutersaheadofthepolicymeeting,asinJoyce,Lasaosa,StevensandTong(2011).

(2) Togiveanexample,arisk-averseinvestorwouldprefer£10forcertainratherthanacointossthatwinseitherzeroor£20(whichhasaprobability-weightedaverage,or‘expected’,pay-offof£10—thesameasthecertainoption).

(3) AsinDeSantis(2016),weuserealisedvolatilityinstockmarketreturnsforthesectorofissuerasaproxyforexpecteddefaultrisk.

(4) SeeEuropeanCentralBank(2016).

178 Quarterly Bulletin 2017 Q3

Itisdifficulttojudgethelong-runimpactonspreadsarisingfromtheScheme,givenchangesinotherfactorswhichhaveaninfluenceonthepriceofbonds.Abstractingfromthoseinfluences,itseemsreasonabletosupposethatanyincreaseinbondpricesarisingfromcentralbankpurchasesshouldremaininthepricelevelforaslongasthoseassetsareheld.However,lowerspreads,andimprovementsinmarketfunctioning,willtendtocauseanendogenousresponseinthesupplyofbonds(issuance).Andthatwillpushdownonbondprices.

Impact on corporate bond issuancePriortotheAugust2016MPCannouncement,itwasuncertainhowresponsiveissuancewouldbetotheCBPS.Somemarketparticipantssuggestedthattheimpactmightbelimited,duetotheperceivedstructuraldeclineofthesterlingbondmarket.(1)Intheevent,however,sterlingissuancerosesharplyfollowingtheannouncement(Chart 6).

Totalsterlinginvestment-gradeissuancebyPNFCswas£10.5billioninAugustandSeptember2016.Thevastmajority

ofthatcamefromUK-domiciledPNFCs,whichissuedaround£8.6billionofsterlinginvestment-gradedebtinthattime(Chart 6).AndSeptembersawrecordmonthlysterlinginvestment-gradeissuanceforUKPNFCs(£5.4billion).Sofar,thereislittleevidencetosuggestthattherehasbeenanincreaseinthenumberoffirst-timesterlingissuersduetotheScheme.Chart 7showsthatthenumberofsuchfirmslooksbroadlyinlinewithrecentnorms.

Theoverallriseinissuanceislikelytohavebeenatleastinpartduetotheimprovementincompetitivenessofthesterlingmarketresultingfromtherelativedeclineinsterlingspreadscomparedwiththoseineuroanddollar(afteraccountingforthecostofhedgingexchangeraterisk),aswell

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Sources:ThomsonReutersDBIandBankcalculations.

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Sources:ThomsonReutersDBIandBankcalculations.

(a) Monthlydata.

(1) ForfurtherdiscussionofchangesinthesterlingcorporatebondmarketseeElliottandMiddeldorp(2016).

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Topical articles Corporate Bond Purchase Scheme 179

asimprovedliquidity.Thatsaid,somecontactsalsosuggestthatthesurgeinissuancefollowingtheannouncementmightbeduetocatch-upforlowlevelsofissuanceearlierintheyear,withissuancehavingbeensubduedinthemonthsprecedingtheUKreferendumonmembershipoftheEuropeanUnion.

Notwithstandingpent-upsupply,contactsalsoreportedthatthereweresterlingdealsthatcouldnothavebeendone—atthematurityorsizethatwasachieved—wereitnotfortheScheme.AndcontactsoftheBank’sAgentsreportedthatasmallnumberoflargercorporateshadbecomemoreinclinedtoborrowinthesterlingmarketthanelsewhere,atthemargin,asaresultoftheimprovedliquidityandcompetitivenessofthesterlingmarket.Thiswouldsuggestthatthepickupinsterlingissuancewasnotjustduetocatch-up.

Whilethepickupwasparticularlysharpinitially,itisnoteworthythatsterlingissuancebyUK-domiciledinvestment-gradePNFCsremainsrobust.Indeed,amongUKPNFCs,thereappearstohavebeenarenewedpreferenceforissuinginsterling,ratherthanothercurrencies,sincetheannouncementoftheScheme.AsaproportionofUKPNFCs’totalbondissuance,theshareofsterlingrosefromaround15%inearly2016toaround40%inApril2017—representingthehighestproportionofissuancesince2007(Chart 8).Partofthisreflectsafallintheshareofeuroissuance,whichhadincreasedsimilarlysharplyfollowingtheannouncementoftheEuropeanCentralBank’sCorporateSectorPurchaseProgrammeinMarch2016.

Takentogether,thesharppickupfollowingtheannouncement,robustissuancesince,andtheassociatedmarketintelligence,areconsistentwiththeviewthatcorporatebondpurchasesmight,poundforpound,haveagreaterimpactonactivitythangiltpurchases.

Impact on liquidityMarketintelligencegatheredshortlyaftertheannouncementoftheAugust2016policypackageindicatedthattherehadbeenanotableimprovementinliquidityinthesterlingcorporatebondmarket.SoonaftertheannouncementoftheScheme,dealersreportedthatthepresenceofthecentralbankhadgiventhemgreaterconfidenceintheirabilitytosellbonds—makingthemmorewillingtointermediateflowsfromclients.Therewerealsoreportsoftheentryofnew,sometimesforeign,buyersintothemarket.

Thedeclineintheexcessbondpremium,whichreflectscompensationforriskaversionandilliquidity,immediatelyfollowingtheannouncementoftheSchemesuggeststhattheremightbearoleforimprovedliquidityindrivingtheobservedfallinbondspreads.Totrytoseparateouttheparticularinfluenceofliquidity,weuseanothermodelofthecorporatebondspreadtotrytoestimatejustthecomponentofthespreadthatcompensatesinvestorsforilliquidity.(1)Whilethesetoffirmsunderlyingthismeasureincludesfinancials,soisnotdirectlycomparabletotheearlierexercise,itisneverthelessinstructivetonotethesharpfallintheliquiditypremiumfollowingtheannouncementoftheCBPS,andthatthisaccountsformostofthedeclineinthespreadobservedinthefewdaysthatfollowed(Chart 9).

Thefallintheexcessbondpremiumand,withinthat,theliquiditypremium,providessupportfortheviewthat,poundforpound,purchasesofcorporatebondsmighthavearelativelybiggerimpactonactivitythangiltpurchases.

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Chart 9 Decomposition of financial and non-financial sterling-denominated investment-grade corporate bond spreads(a)(b)

Sources:BankofAmericaMerrillLynchGlobalResearch,Bloomberg,ThomsonReutersDatastreamandBankcalculations.

(a) ImpliedliquiditypremiaareestimatedusingaMertonmodelasinLelandandToft(1996)todecomposecorporatebondspreads.

(b) Dataasat31May2017.

(1) ForadiscussionofthemodelseeChurmandWebber(2007).

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Conclusion

Thisarticleprovidesanoverviewofthedesign,operationandfinancialmarketimpactoftheBank’sCorporateBondPurchaseScheme.ThedesignoftheSchemetookintoaccountthebroadpurposeofcorporatebondpurchases—toimpartmonetarystimulusbyloweringtheyieldsoncorporatebonds,pushinguponriskyassetpricesingeneral,andstimulatingnewissuanceofcorporatebonds—aswellastheparticularfeaturesofthesterlingcorporatebondmarket.

Basedonarangeofmetrics,wefindthattheCBPShadadiscerniblepositiveimpactonthesterlingcorporatebondmarket.Sterling-denominatedinvestment-gradePNFCbondspreadsfellbyaround20basispointsinthedaysfollowingthe

announcementoftheScheme.IssuanceinsterlingbyUK-domiciledPNFCspickedupsharplyfollowingtheannouncement,andremainsrobust.Andtherehasbeenanimprovementinmarketfunctioningandliquidity.Thisprovidessomesupportfortheviewthatcorporatebondpurchasesarelikelytoprovideagreaterboosttoactivity,poundforpound,thananequivalentamountofgiltpurchases.

Whilethedirectimpactonthecorporatebondmarketisencouraging,itisstilltooearlytoassessfullythetransmissionoftheCBPStotherealeconomy.Fornow,theMPChasdecidedtomaintainthestockofcorporatebondpurchasesat£10billion.Futuredecisionsregardingwhethertoincreaseorreducethestockofcorporatebondswillbegovernedbytheeconomicandfinancialcircumstancesatthetime.

Topical articles Corporate Bond Purchase Scheme 181

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Churm, R and Webber, L (2007),‘Decomposingcorporatebondspreads’,Bank of England Quarterly Bulletin,Vol.47,No.4,pages533–41,availableatwww.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb070403.pdf.

De Santis, R (2016),‘Creditspreads,economicactivityandfragmentation’,European Central Bank Working Paper No. 1930.

Elliott, D and Middeldorp, M (2016),‘Whatexplainsthefallinsterlingcorporatebondissuance?’,availableathttps://bankunderground.co.uk/2016/04/01/what-explains-the-fall-in-sterling-corporate-bond-issuance/.

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Gilchrist, S and Zakrajšek, E (2012),‘Creditspreadsandbusinesscyclefluctuations’,The American Economic Review,Vol.102,No.4,pages1,692–720.

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Joyce, M, Tong, M and Woods, R (2011),‘TheUnitedKingdom’squantitativeeasingpolicy:design,operationandimpact’,Bank of England Quarterly Bulletin,Vol.51,No.3,pages200–12,availableatwww.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb110301.pdf.

Leland, H and Toft, K (1996),‘Optimalcapitalstructure,endogenousbankruptcy,andthetermstructureofcreditspreads’,Journal of Finance,Vol.51,No.3,pages987–1,019.

Salmon, C (2017),‘Marketfunctioning’,availableatwww.bankofengland.co.uk/publications/Documents/speeches/2017/speech955.pdf.