EU Commission Reviews Bond Liquidity

Shanny Basar

The European Commission has acknowledged that the cumulative affect of regulation has affected liquidity in the corporate bond market and could take further action to address the issue.

Niall Bohan, Head of Unit, Capital Markets Union at the European Commission made a keynote speech Thursday at the Association for Financial Markets in Europe’s Market Liquidity Conference in London.

Bohan said the Commission is aware of the stresses in the secondary corporate bond market in Europe, and this has been the focus of discussions with the the institutional sell side and buy side.

He said: “There has been a dichotomy between the public and private sector as regulators such as France’s AMF and the Bank of England found no evidence of less liquidity. However PwC and the International Capital Market Association have reported there is less liquidity, especially in the repo market at end of last year.”

Icma said in a report this month that extreme volatility and market dislocation experienced in the euro repo market in the last week of December last year were unprecedented in the post-euro era.

The report said: ‘“The euro repo and short-term funding markets effectively broke down, something that did not happen either during the Lehman crisis or over the sovereign bond crisis. As the European Central Bank’s bond purchase programs are set to continue, and as more regulation puts pressure on banks’ balance sheet and intermediation capacity, there is a very real concern that the market behaviour over the 2016 year-end is not a ‘one-off’ event, and could herald the start of a new normal.”

Icma had responded to the EU Commission’s Call for Evidence on the impact of cumulative regulation since the crisis by saying that fixed income market-making was seriously compromised by different pieces of regulation.

For example, the Capital Requirements Directive has made balance sheet for banks and broker-dealers far more expensive and the provisions under the Fundamental Review of the Trading Book are expected to significantly increase the capital required for fixed income market-making.

“Further regulatory initiatives, such as CSDR [Central Securities Depositories Regulation] mandatory buy-ins and MiFID II/R pre- and post-trade transparency requirements, may only serve further to render the market-making model economically unviable and obsolete,” added Icma.

Bohan said at the AFME conference that regulators have already taken steps and adapted pre-trade transparency requirements for corporate bonds in MiFID II, as well as changing the mandatory buy-in in the Central Securities Depositories Regulation.

“The chapter is not closed,” he added. “The expert group is important and will respond to specific considerations.”

The European Commission created a 17-member expert group to review corporate bond market liquidity under the action plan for a Capital Markets Union in the region. Bohan said the expert group will make public recommendations by September and the Commission will then decide whether to accept the advice by the end of this year.

Bohan added: “However, regulators introduced rules such as the leverage ratio and the review of the trading book to deliberately derisk parts of financial system so you should not expect the clock to be turned back.”

He continued that the expert group is also considering the impact of the growth of exchange-traded funds, the electronification of fixed income and possible fintech innovations.

Bohan said the corporate bond market will be an important driver of the CMU, which aims to increase non-bank financing in the EU.

“Corporate bonds will be the first train to pull the CMU train forward,” he said. “We will look to make it easier to distribute private placements and ease capital requirements.”

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