EU Assesses Corporate Bond Markets

Shanny Basar

The European Commission has recommended that industry groups representing the buy side, sell side and trading venues, including fintech firms, should issue guidance papers on good practices for electronic trading in corporate bond markets.

The Commission said the value of European corporate bond markets represents 10% of GDP in 2017, less than a third of the 31% in the US. As a result the functioning of European corporate bond markets needs to be efficient and there are also concerns about a perceived decrease of liquidity in secondary markets and fragmentation along national lines according to a study, Improving European Corporate Bond Markets.

The Commission set up an expert group of 17 market participants who met nine times between November last year and October 2017. The report said: “The expert group urges policy-makers to avoid attempts to reform bond markets drawing on analogies with the functioning and characteristics of stock markets. Such attempts risk leading to false and counterproductive conclusions.”

The expert group made 22 recommendations covering six objectives: making issuance easier for companies; increasing access and options for investors; ensuring the efficiency of intermediation and trading activities; fostering the development of new forms of trading and improving the post-trade environment; ensuring an appropriate level of information and transparency; and improving the supervisory and policy framework.

The report estimated there are 32 electronic fixed income trading platforms in Europe. The study continued that electronic platforms permit users to efficiently source liquidity from multiple dealers; give access to small or new players; reduce transaction costs and make pre- and post-trade transparency simpler.

“To support the development of a strong e-trading system, industry groups representing the buy side, the sell side and all trading venues, including fintech firms, should issue guidance papers on good practices for electronic trading,” said the study. “In addition, stakeholders should benefit from some regulatory leniency when testing new models (regulatory sand boxes), in particular for best execution and transaction reporting.”

In addition, the development of platforms which connect participants in the market and facilitate price discovery is proving beneficial as are all-to-all networks, allowing buy-side firms to trade with one another. The study recommended that electronic platforms should evolve to better integrate trading systems with order management systems to increase efficiencies and reduce search costs.

As well as making trading more efficient, post-trade processes need to be improved as the environment in Europe is still highly fragmented with most central securities depositories being interoperable. The Commission warned: “Closed business models also stifle innovation.”

The report highlighted that most European central counterparty clearing houses still do not offer open access, even though this is mandated by regulators from 2020. As a result, only a fraction of European corporate bonds are cleared, hampering centralised processing, settlement netting and optimisation.

“Greater standardisation and fewer, larger issues would support access to clearing,” said the report. “CCP services designed to simplify trade processing and settlement could be extended to more non-cleared fixed income trades, improving standardisation and efficiencies without requiring legal novation.”

The expert group recommended that the European Commission reports next year on how barriers to greater fixed income clearing are being addressed.

In the primary market the report said demand for new issues is often far more than the supply which leads to some investors to inflating their orders top the detriment of other investors. There are clear and transparent rules on allocations in the investment grade market, but not in high-yield.

“Regulators should work with market professionals to support the extension of transparent and fair allocation methods from the investment grade primary market to the high yield segment as appropriate,” said the report. “This will warrant a fairer access to primary liquidity for all borrowers and investors and a transparent and efficient price discovery process.”

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