Bond Liquidity Woes Vary By Region

Shanny Basar

Bond market liquidity has improved in Asia Pacific over the last five years but deteriorated in the Americas and Europe, Middle East and Africa according to a survey from the CFA Institute.

Sviatoslav Rosov, an analyst in the capital markets policy group, wrote on the CFA Institute’s blog yesterday that respondents from the Americas and Emea said bank capital and liquidity regulations have significantly reduced bond market liquidity and policymakers should focus on removing impediments to the smooth functioning of institutional wholesale markets. However in Asia Pacific respondents said no single factor has had a very significant impact on bond market liquidity.

“A broad brush reading of the survey results seems to suggest that bond market quality concerns are mostly an Americas and Emea problem, with Asia Pacific respondents experiencing relatively more positive changes in recent years,” added Rosov.

The survey had responses from 513 CFA members. The majority, 53%, were from the Americas, 29% from the Europe, Middle East, and Africa and 18% from Asia Pacific. Approximately half, 51%, of respondents were from the buyside, 13% from the sellside, 9% straddled both and 27% selected “neither.”

Respondents from the Americas and Emea said that over the last five years there has been a decrease in  corporate bond liquidity, but no change for government bonds. They also reported a fall in the number of active dealers making markets, an increase in the time taken to execute trades, a lower proportion of bonds being actively traded and more unfilled orders.

In contrast, respondents in Asia-Pacific said that over the same period there was no change in the liquidity of high-yield corporate bonds and an improvement for both investment grade corporate bonds and government bonds. In addition the number of active dealers making markets and the proportion of bonds being actively traded had both risen.

All three regions agreed that dealers are increasingly focusing on servicing larger clients at the expense of smaller clients, with an average of 69% of respondents choosing this option.

In all three regions, a plurality or majority of respondents said the growth in electronic trading in the secondary corporate bond market has had little to no impact on liquidity. However, 30% reported improved liquidity as a result of technological changes and very few think technology has had a negative impact.

This month four fixed income trading platforms launched the Electronic Debt Markets Association Europe to provide market data to regulators on an ongoing basis. BrokerTec Europe, MarketAxess Europe Limited, MTS Group and Tradeweb Europe launched EDMA Europe to co-ordinate the standardization of data, which can be used to set large-in-scale and liquidity thresholds.

New regulations will have a further impact on secondary bond liquidity in the European Union. MiFID II. which comes into force from 2018, introduces new pre-trade and post-trade requirements for fixed income markets and also looks to define liquid instruments. For example, bonds will be assessed every quarter to determine liquidity  on an instrument by instrument approach and liquid bonds will have higher transparency requirements. In addition, the pre-and post-trade transparency requirements will also depend on whether trades are defined as large-in-scale.

In a paper in 2014 BlackRock had recommended  that bond liquidity could be enhanced if investor holdings and trading activity were not spread across a vast number of individual securities. As a result trading has become fragmented across the bond universe, with few liquid issues.

“Standardization would reduce the number of individual bonds, via steps such as issuing similar amounts and maturities at regular intervals and re-opening benchmark issues to meet ongoing financing needs,” added BlackRock. “Standardized terms would improve the ability to quote and trade bonds, and would create a liquid curve for individual issuers.”

Rosov said it would be easier to  move standardized bond trading onto electronic trading platforms.

“In an all‐to‐all environment, there should be an increased probability of finding a counterparty to trade with, which may become more important if there are fewer dealers (or less‐active dealers) making markets,” added Rosov. “Standardization may take a variety of forms but is considered helpful in facilitating exchange‐type trading.”

In the CFA survey a majority in Asia Pacific and Emea, and 46% in the Americas, think standardization is a desirable goal.

The survey also found that across the three regions a small plurality of respondents agreed that exchange-traded funds improve overall bond market liquidity. However a significant minority, 44% in Asia Pacific, said ETFs do not impact liquidity.

“However, it is unclear whether deep liquidity in ETF markets is representative of liquidity in the underlying” added the survey. “Furthermore, it is also unclear to what extent a liquidity mismatch between the underlying bond market and the ETF market may be problematic.”

In the first nine months of this year fixed income ETFs/ETPs had record year-to-date inflows of $100.67bn, 56% more than the previous high of $64.14bn,which was set last year according to ETFGI, the research and consultancy firm.

The fixed income flows contributed to total net inflows of $238.12bn in the first nine months of the year, slightly down from the $251.67bn gathered in the same period sat year. Equities had inflows of $85.55bn while commodities gathered record year-to-date assets of $36.55bn, overtaking the previous record from 2012.

In the first three-quarters of this year assets invested in ETFs/ETPs listed globally reached a record of $3.408 trillion according to preliminary data from ETFGI’s September 2016 global ETF and ETP industry insights report.

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