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Eurozone Central Bank’s Reverse Auction Pilot Program

During the month of October, the central banks of France, the Netherlands and Lithuania experimented with using reverse auctions to make purchases under the European Central Bank (ECB)’s large-scale bond-buying program. This system is similar to the one employed by the U.S. Federal Reserve in its own quantitative easing program and could potentially improve the transparency of the buying process. Overall, there is no change to the quantitative easing program since the reverse auction trials only affect a small part of the overall monthly purchases and also coincide with regular purchases of public-sector assets. One of the participating banks, the Bank of France, reported the successful completion of its first reverse auction on October 16. Prior to its auction, the Bank of France released a list of the International Securities Identification Numbers of the securities to be acquired. The trial allowed many counterparties to submit bids on four European Financial Stability Facility (EFSF) debt securities. The process was carried out by the Bloomberg auction system.

The overarching goal of the pilot program is to gain experience in using reverse auctions to carry out public sector asset purchases of government, agency, and supranational securities under the quantitative easing scheme without fully committing to including auctions in future asset purchase programs. According to Haoxiang Zhu, an assistant processor of finance at MIT, “Auctions encourage competition, offer more transparency and concentrate market-wide liquidity.”

The auction system being used by the ECB is different from the auctions studied in class because the bidders of a reverse auction are “sellers” and not “buyers,” but the basic principle of an auction is still the same. In other words, a reverse auction is an auction in which potential sellers are competing to undercut one another on price, such that the lowest bid is the winning bid. For the purposes of the ECB’s pilot program, a reverse auction entails sellers offering bonds from a list released prior to the auction for the central bank to buy. This is a much more direct approach to purchasing bonds than the purchases made by bank dealers on the behalf of the central bank in the past. In short, though the reverse auctions increase transparency, they also reduce flexibility in the Eurozone, making it a challenge to be implemented across the entire quantitative easing program.



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October 2015