- NatWest withdrew its markets securities business from the Federal Reserve Bank of New York’s list of primary dealers, effective Friday, as it pulls back from US and European government bond markets. It remains a primary dealer in the UK gilt market.
- The decision follows a long retreat rather than a recent judgement. The bank’s markets unit has shrunk substantially since its days as Royal Bank of Scotland, and in 2020 the group cut the business to focus on UK retail and commercial lending. A person familiar said the move was unrelated to recent bond market volatility.
- The timing is nonetheless uncomfortable. The US Treasury is weighing cancellation of its 20-year bond because that maturity lacks a natural buyer base, France is issuing less 30-year debt after dealers reported weak demand, and Bloomberg has reported that a $50 trillion issuance deluge will test already strained dealer infrastructure.
- Last week’s 10-year auction cleared with a record 97.5% going to non-dealer buyers, meaning dealers absorbed almost nothing of the supply.
What Happened?
A NatWest spokesperson said last week the Edinburgh-based bank was simplifying its markets business structure and proposing to withdraw from primary dealership programmes in the US and Europe. A representative did not immediately respond to a request for further comment on Friday.
Why It Matters?
The record non-dealer auction take-up cuts in two directions and the distinction matters. If end investors absorb supply directly at auction, dealers are less essential to the primary issuance process, which is the reassuring reading. But dealers provide liquidity in the secondary market between auctions, standing ready to transact size when others will not, and that function is where a withdrawal is felt. It shows up in bid-ask spreads and in the capacity to move large positions during stressed conditions, not in auction statistics. One fewer balance sheet committed to that role is a small change in an environment where the direction of travel is already wrong. The economics behind the decision explain why this keeps happening. Primary dealing is capital-intensive and low-margin, and post-crisis capital rules make holding government bond inventory expensive relative to the return. NatWest concluded in 2020 that UK retail and commercial lending offered better returns and has been executing that strategy since. The decision is rational for the bank and unhelpful for the market, which is a collective action problem with no obvious solution: no individual institution has an incentive to maintain a loss-making function for systemic benefit. Retaining UK primary dealership while exiting the US and Europe is consistent with a domestic focus, and the gilt market has its own difficulties, with 10-year yields at 5.37% against 5.09% for Treasuries and a budget due October 28. For investors the practical point is that government bond market liquidity depends on a shrinking number of intermediaries at a time when issuance is growing, which is the structural backdrop to the auction and issuance stories running through recent weeks.
What Next?
Watch whether other banks follow, since the economics that prompted this apply across the dealer community. The Treasury’s quarterly refunding statement on November 4 will indicate how it intends to manage issuance, including any decision on the 20-year bond. Auction statistics, particularly dealer take-up and bid-to-cover ratios, are the running measure of whether intermediation capacity is adequate. Secondary market liquidity metrics matter more than auction results for judging the effect of this particular departure.
Affected Tickers and Coins: NWG, ZN, ZB
Source: Bloomberg
