The Dutch Direct Auction (DDA) is a transparent and rule-based auction technique designed by the DSTA for the auctioning of government debt securities.
Image: Outlook 2016
The DDA was first used in June 2003 for the primary issuance of a 5-year bond. The goal of the DDA is twofold, firstly to engage a broad investor base and secondly to auction government debt at the best price possible. Investors can participate directly in the DDA of the new Dutch government bond through one (or more) Primary Dealer(s). The DDA is one of three auction techniques used by the DSTA. It is used for the primary issuance of longer dated bonds (5-, 10-, and 30-years). For the primary issuance of the 3-year bonds the regular tap auction is used. The tap auction is also used to reopen bonds after they have been issued.
The DDA is governed by a clear set of rules, which are kept unchanged in time as much as possible. In the DDA bids are not submitted as an absolute price but as a spread against a reference bond, most often a German Bund with a comparable maturity to the bond on auction. This method has been chosen because there is a time lag between placing the orders and the actual allocation. During this period the market might move resulting in an absolute price level not correctly reflecting the market price. Because spreads are less volatile than absolute price levels the market price of the bond is better reflected as a spread over a reference bond. A range of the yield spreads, called the ‘spread guidance’, at which orders can be placed, is communicated to investors prior to the auction (mostly the day before). The investor indicates per spread what quantity, with a minimum of 1000 euros, of the bond he wants to receive. This allows the investor to directly participate in the price discovery process. Apart from bids at certain spreads investors also have the opportunity to place bids ‘at best’. These bids will be regarded as bids against the lowest spread in the ‘spread guidance’.
The liquidity and market stability of newly issued bonds are supported by a balance between long- and short-term investors. To ensure an adequate balance, investors are divided in two categories: the category ‘real money’ (long term) investors which covers central banks, insurance companies, and pension funds. And the category ‘other’ (short term) investors that covers, among others, banks and hedge funds.
After the auction book is closed the DSTA allocates the bonds to investors at a uniform ‘cut-off spread’. Orders at spreads below the ‘cut-off spread’, including the ‘at best’ orders, are always allocated in full. Orders at the ‘cut-off spread’ may be allocated only partially. At the ‘cut-off spread’ bids from ‘real money’ clients are allocated first. If after full allocation of ‘real money’ orders at the ‘cut-off spread’, funding is still required, then ‘other’ accounts will be allocated. In order to ensure a healthy balance between the two investor categories the DSTA reserves the right to allocate 35% of the total volume to the ‘other’ category. After the allocation the issuance price is set and communicated to investors.
More information on the DDA process and allocation mechanism can be found in the DDA presentation.