This document discusses the implementation of the European Central Bank's Public Sector Purchase Programme (PSPP) and its impact on bond markets. Some key points: - Over €5 trillion in bonds globally are trading at negative yields, with over €9 trillion in G7 countries' bonds at negative rates. - In the EU, €3.2 trillion or 50% of outstanding bonds are at negative yields. Low yields increase interest expenses for governments but reduce participation in bond markets. - An increase in issuer limits under PSPP may modestly extend the time until the ECB exhausts its pool of eligible German bonds, while increasing overall portfolio duration and the percentage of government bonds held. This could affect pricing along

1. PSPP’s implementation rules: impact on markets and
challenges ahead
Cristiana Corno, Rates Strategist, Global Markets-Trading, Banca IMI
Fabrizio Ligurgo, Internship Strategist, Global Markets-Trading, Banca IMI
15th July 2016

2.  Bis (March2016 Quarterly Review) calculates that 5.3 trillion € value in bonds are trading
at negative yield or 25% of the Boa Merrill Lynch world Sovereign index.
 At G7 level, an amount of approx. 9 trillion € is trading at negative rates, or 30% of
the total outstanding amount (fixed coupon bonds).
Negative yields unconventional … but contagious
2
Source: Bis Quarterly Review (March 2016)
Amount of debt trading at negative yield, using as
reference the Boa Merrill Lynch world Sovereign index.
Debt amount trading at negative yield in G7: amount and
percentage on total outstanding
Source: Bloomberg data, Banca IMI calculations
0%
5%
10%
15%
20%
25%
30%
35%
0
1
2
3
4
5
6
7
8
9
10
Trillions
Outstanding Amount (value)
Outstanding Amount (%)

3.  It is interesting to look at each bond market as if they were portfolios: average yield to
maturity has diminished and interest rate risk in the market has increased delivering
a low risk/reward asset
Bonds: unconventionally low risk reward
3
Source: Bloomberg data, Banca IMI calculations
Weighted average yield (issue’s outstanding amount) of
selected markets.
Increase in G7 market outstanding weighted duration and
decrease in weighted average yield
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
5
5.2
5.4
5.6
5.8
6
6.2
6.4
Duration
Weighted yield
Weighted average yield
Switzerland -0.66
Germany -0.38
Japan -0.21
Netherlands -0.30
Austria -0.27
Denmark -0.12
France -0.12
Sweden -0.19
Belgium -0.11
Ireland 0.01
Spain 0.56
Italy 0.66
Portugal 2.10

4.  At EU level, an amount of approx. 3.2 trillion € is trading at negative rates, or 50%
of the total outstanding amount (fixed coupon bonds).
Negative yields in EU
4
Weighted yield and duration in EU fixed income markets Debt amount trading at negative yield in the Eurozone:
amount and percentage on total outstanding
Source: Bloomberg data, Banca IMI calculations
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
6.4
6.6
6.8
7.0
7.2
7.4
7.6
7.8
8.0
Weighted Duration
Weighted Yield
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
1.0
1.5
2.0
2.5
3.0
3.5
Trillions
Outstanding
Amount (value)

5. Unconventional … driving asset allocation decision
5
Source: Banca IMI calculations
Swiss private sector change in asset allocation decision
 At country level, we can expect some shift from fixed income to alternative/managed
funds as it happened in Switzerland (shifting from bonds to UCITS funds, with the
allocation to equities almost unchanged).

6. Assets for exclusive players
6
Italian debt percentage holdings 2008-2015 (Bank of Italy data) Italian interest expenses as percentage over GDP (Mef data
1990-2009). Currently at 4.2% of GDP
 If low yield levels represent a short term benefit for the governments in terms of lower
interest rate spending, they also change the structure of the market by reducing
significantly the number of active players.
 In Italy, the share of government debt held by domestic non financial agents fell from
20% in Jan 2008 to 5.0% in Feb 2016, with banks, insurers and central banks
increasingly filling the gap.
22%
26%
21% 5%
0.0%
25.0%
50.0%
75.0%
100.0%
Jan 08 Jan 10 Nov 11
(debt
crisis)
Nov 12 Jun 14
ECB
depo cut
to -
0.10%
Dec 14
ECB's QE
Dec 15
ECB's
QE2
Feb 16
Other residents Other FI Banks Non residents
Source: Banca IMI calculations

7. In Italy: higher holding, higher correlation?
7
Increased market correlation (Bloomberg data)
 Since the beginning of the year, the correlation between Btp-Bund spread and financial
risk has increased, notwithstanding EBRRD adoption.
Source: Bloomberg Data

8. Evolution of holdings in main Europeans
8
0%
10%
20%
30%
40%
50%
60%
70% GERMANY
Central Bank Credit Institutions
other domestic non banks Non-residents
0%
10%
20%
30%
40%
50%
60%
ITALY
Central Bank OMFIs
Other financial institutions Other residents
Non-residents
0%
10%
20%
30%
40%
50%
60%
SPAIN
Central Bank OMFIs
Other financial institutions General government
HHs and NPISHs Rest of the world
non-financial corporations
0%
10%
20%
30%
40%
50%
60%
70% FRANCE
insurance companies credit instituions OPCVM money funds
other residents non-residents
Source: CB’s and Bruegel http://bruegel.org/2016/05/sovereign-bond-holdings-in-the-euro-area-the-impact-of-qe/
Rest of
the world
up
Residents
down

9. Hot Topic: Bund scarcity issue
9
How many months Bundesbank to exhaust the pool of eligible bonds?
We tried an empirical approach, under 2 assumptions:
 our universe is the pool of German securities available for lending at ECB and
bilateral lending (approx. 1.1tr nominal, 1.3tr countervalue): sovereign, agencies and
regional bonds.
 we have assumed that the CB, solves an optimization problem in determining the
nominal amount of each bond, in order to minimize the Mean Squared Error, where
the mean is the average percentage of nominal purchased on issue’s
outstanding.
Under these assumptions, and the constraints of matching the amount and the
duration bought by the CB and communicated monthly, we have built a PSPP replicating
portfolio.
Source: Banca IMI calculations
Possible maturity distribution and sector composition-
overall portfolio
Average duration of main CB’s purchases under QE,
ECB data

10. Hot Topic: Bund scarcity issue
10
Currently the pool of eligible is 230bn (value) reduced to 95bn due to depo limit, equivalent
(assuming 15b a month) to 6.32 months to exhaustion. BUT:
 the length to exhaustion is a function of the yield level;
 the eligible bonds are high duration bonds: the exhaustion of the pool will increase
the portfolio duration from 7.45 to 11.4 and the govies percentage from 65% to 74%.
Source: Banca IMI calculations
Change in yield from current level and months to exhaustion
0
2
4
6
8
10
12
14
16
0
50
100
150
200
250
0.5 0.4 0.3 0.2 0.1 0 -0.1 -0.2 -0.3 -0.4 -0.5
Billions
months pool y>depo
Eligible pool composition – only long end bonds
duration 7.4460
agencies 31%
govt 65%
regional 4%
duration 11.3973
agencies 23%
govt 74%
regional 3%

11. Hypo replicating portfolio: agencies
11
The agencies replicating portfolio we obtained has a lower duration (4.5 versus 7.45
overall portfolio) compared to the entire portfolio.
Almost all the securities in the portfolio have reached the 33% cap. Due to the yield
constraint, an eventual increase in the issuer cap for non Cac bonds will only increase the
purchase in the long end.
Source: Banca IMI calculations
Possible maturity distribution - agencies portfolio Almost all the securities have reached the 33% cap
Avaiable nominal to buy if cap is increased to 40% (agencies only)

12. Hypo replicating portfolio: bunds
12
The bund portfolio has a higher duration (8.9) and it is made up by 42% Cac-ed securities
(58% not Cac-ed). The buying has been probably concentrated in 7-10y bucket.
In the Bund portfolio, the most of the securities has not reached the 33% cap but the yield
constraint limits possible purchases to the long end. If Buba were to buy the residual
securities, the portfolio duration would increase from 8.9 to 13.7
Source: Banca IMI calculations
Possible maturity distribution - bund portfolio Bund purchases have been probably concentrated in 7-10y
Avaiable nominal to buy on the Bund curve - long end only

13. Hypo replicating portfolio: regionals
13
The regional portfolio has a lower duration (6.85) and it is probably already capped at
33%.
Due to the higher yield level, an increase in issuer limit will increase the amount of
regional buying along the overall curve.
Source: Banca IMI calculations
Possible maturity distribution – regional portfolio Regional bonds are already capped at 33%
Avaiable nominal to buy on the regional curve – if cap increased to 40%

14. 14
 As shown in table below, an increase in the issue cap would not change
significantly the number of months to exhaustion.
 At current yield level, the change will increase the amount eligible in the long end
of the bund curve, therefore increasing the overall portfolio duration.
Change in eligible pool if issue cap is increased to 40% and
50% on non Cac-ed securities
Source: Banca IMI calculations
Increase of issue cap for non Cac securities
ISSUE LIMIT
40% 50%
All 9 (+2.5) 12.4 (+6)
Only
non-Cac
8 (+1.7) 10.2 (+4)
Months to exhaustion in case of QE terms
rearrangement (increase from current situation)
0
2
4
6
8
10
12
Billions
33%
40%
50%
duration 7.4460
agencies 31%
govt 65%
regional 4%
duration 12.6025
agencies 22%
govt 74%
regional 4%

15. 15
 The non Cac-ed securities in the long end are trading very rich. However, if
yield were to increase or depo limit to be removed, while increasing the
cap to 40% on non Cac-ed securities, the amount to be bought would
change along the curve (chart below) and it could possibly richen the non
Cac-ed securities in the mid part of the curve.
Change in eligible pool if issue cap is increased to 40% and yield
limit is not more binding anymore
Source: Banca IMI calculations
Increase of issue cap for non Cac securities: possible
trade
-
1
2
3
4
5
6
7
8
9
Billions
B ond Name Las t av g min max s tde v ze ta
BKO 0 09/15/17 0.00 0.00 -0.50 0.00 0.04 Cacs
OBL 0 1/2 10/13/17 -0.01 -0.72 -3.64 1.09 0.94 0.75
BKO 0 12/15/17 0.00 -0.01 -0.39 0.00 0.05 Cacs
DBR 4 01/04/18 -3.74 -1.68 -5.12 0.19 1.29 -1.60
OBL 0 1/2 02/23/18 0.00 0.00 -0.35 0.00 0.02 Cacs
BKO 0 03/16/18 0.00 0.00 0.00 0.00 0.00 Cacs
OBL 0 1/4 04/13/18 0.00 0.00 -0.29 0.00 0.01 Cacs
BKO 0 06/15/18 0.00 0.00 0.00 0.00 0.00 Cacs
DBR 4 1/4 07/04/18 -0.40 -0.92 -5.19 1.92 1.79 0.29
OBL 1 10/12/18 0.00 0.00 -0.36 0.00 0.02 Cacs
DBR 3 3/4 01/04/19 -0.20 -1.17 -5.59 1.95 2.11 0.46
OBL 1 02/22/19 0.00 0.00 -0.36 0.00 0.02 Cacs
OBL 0 1/2 04/12/19 0.00 0.00 -0.22 0.00 0.01 Cacs
DBR 3 1/2 07/04/19 1.21 -1.06 -5.52 2.95 2.50 0.91
OBL 0 1/4 10/11/19 0.00 0.00 -0.05 0.00 0.00 Cacs
DBR 3 1/4 01/04/20 0.25 -1.52 -5.94 2.17 2.41 0.73
OBL 0 04/17/20 0.00 0.00 -0.16 0.00 0.01 Cacs
DBR 3 07/04/20 1.50 -1.62 -6.01 2.15 2.36 1.32
DBR 2 1/4 09/04/20 -2.07 -2.40 -6.32 0.93 1.69 0.19
OBL 0 1/4 10/16/20 0.00 0.00 -0.21 0.00 0.02 Cacs
DBR 2 1/2 01/04/21 -0.68 -1.73 -5.39 1.20 1.78 0.59
OBL 0 04/09/21 0.00 0.00 0.00 0.00 0.00 Cacs
DBR 3 1/4 07/04/21 -0.42 -1.51 -5.07 1.80 1.62 0.67
DBR 2 1/4 09/04/21 -1.21 -1.90 -5.11 0.42 1.42 0.49
DBR 2 01/04/22 -0.68 -1.28 -4.12 1.59 1.14 0.52
DBR 1 3/4 07/04/22 -0.81 -1.24 -3.13 0.77 0.76 0.57
DBR 1 1/2 09/04/22 -0.36 -0.50 -2.34 1.00 0.58 0.23
DBR 1 1/2 02/15/23 0.00 0.00 0.00 0.87 0.04 Cacs
DBR 1 1/2 05/15/23 0.00 0.00 0.00 0.53 0.03 Cacs
DBR 2 08/15/23 0.00 0.00 0.00 0.62 0.03 Cacs
DBR 6 1/4 01/04/24 -0.13 -0.09 -4.20 4.34 1.98 -0.02
DBR 1 3/4 02/15/24 0.00 0.00 0.00 0.53 0.03 Cacs
DBR 1 1/2 05/15/24 0.00 0.00 0.00 0.74 0.04 Cacs
DBR 1 08/15/24 0.00 0.00 0.00 0.54 0.03 Cacs
DBR 0 1/2 02/15/25 0.00 0.00 0.00 0.39 0.02 Cacs
DBR 1 08/15/25 0.00 0.00 0.00 0.65 0.05 Cacs
DBR 0 1/2 02/15/26 0.00 0.00 0.00 0.00 0.00 Cacs
DBR 0 08/15/26 0.00 0.00 0.00 0.00 0.00 Cacs
DBR 6 1/2 07/04/27 -6.23 1.56 -7.08 6.89 2.83 -2.75
DBR 5 5/8 01/04/28 -8.71 2.48 -9.18 9.52 3.94 -2.84
DBR 4 3/4 07/04/28 -10.39 1.42 -10.94 8.15 4.09 -2.89
DBR 6 1/4 01/04/30 -12.03 2.59 -13.38 13.19 6.01 -2.43
DBR 5 1/2 01/04/31 -8.07 5.25 -9.94 13.77 4.91 -2.71
DBR 4 3/4 07/04/34 -10.43 3.19 -11.63 11.58 5.01 -2.72
DBR 4 01/04/37 -8.37 3.32 -9.43 10.28 3.89 -3.00
DBR 4 1/4 07/04/39 -4.71 3.06 -5.99 8.87 2.77 -2.81
DBR 4 3/4 07/04/40 -2.24 3.32 -3.97 8.35 2.29 -2.43
DBR 3 1/4 07/04/42 -2.05 0.05 -3.61 2.57 1.27 -1.65
DBR 2 1/2 07/04/44 -2.17 -1.47 -4.07 0.51 1.11 -0.63
DBR 2 1/2 08/15/46 0.00 0.00 0.00 0.67 0.03 Cacs

16. 16
 The removal of the yield limit would increase the most the eligible universe: from
6.3 to 15 month with 33% cap unchanged.
 Moreover, in this case, the eligible pool is spread on the curve and through
sectors. The exhaustion of the eligible pool in this case would result in a more
balanced portfolio.
Change in eligible pool of Bunds if yield limit is removed
Source: Banca IMI calculations
Removal of yield limit
Months to exhaustion in case of yield limit removal
and increase in issue cap
-
1
2
3
4
5
6
7
8
Billions
duration 7.4460
agencies 31%
govt 65%
regional 4%
duration 8.6390
agencies 15%
govt 83%
regional 2%
ISSUE LIMIT
33% 40% 50%
15 (+9) 19.5 (+13) 25 (+19)

17. 17
 The yield removal could be realized by constraining the average yield
portfolio rather than the single issue yield to maturity.
 Under our assumptions and calculations, the historical yield to maturity of Buba
portfolio should be around 0.18-0.07%; therefore, there is ample room to buy
bonds yielding less than -0.40%. This expedient would have similar effect as
the yield removal (up to a certain negative yield level and depending on the
expected size of the portfolio).
Historical Buba hypothetical portfolio yield to maturity – still positive
Source: Banca IMI calculations
Removal of yield limit: from issue to portfolio
-0.10
0.00
0.10
0.20
0.30
0.40
0.50

18. 18
 A removal of the yield limit would possibly cheapen the long end of the German
curve. Possible trades:
 3010y cash steepening versus swap flattening
 Cheapening of 2034-2037 securities versus non Cac-ed securities (fly below)
 Short Buxl asset swap versus long ITRX Xover protection.
15y-20y area cheapening trade
Source: Bloomberg data, Banca IMI calculations
Removal of yield limit: possible trades
Divergence between Bunds asset swap level and Credit proxy

19. 19
 In table, we show how things would change, assuming buying based on relative
“sovereign only” market size, rather than capital key. Italy increases the most in absolute
and relative value, followed by France; the amount of purchasing in Germany is reduced
by 33%, from 15b to 10b, monthly.
 The number of months would increase to 3, so the scarcity issue is not efficiently
addressed.
Change in PSPP relative buying
Source: Banca IMI calculations
From capital to sovereign quote
Germany
-5b monthly
Italy
+5b monthly

20. 20
 Long Btp-Bund spread with duration short 30% of spread trade DV01, suggested at
0.96 as a defensive play. Original stop 1.06, target 0.80.
Long Btp versus short Bund in 10y maturity (0.7 versus 1 DV01 weights)
Source: Bloomberg data, Banca IMI calculations
Trade works in a risk-on scenario.
From capital to sovereign quote: possible trade

21. 21
Disclaimer
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22. 22
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