European Bond Liquidity Slips

Shanny Basar

Liquidity in both euro and sterling investment grade and high yield bond markets has declined since last April according to the International Capital Markets Association.

Icma said in its first quarter report for this year that it had asked ICE Data Services to establish a way to track fixed income liquidity with the starting reference point as 27 April 2016.

The report said: “With the permission of ICE Data Services, Icma intends to publish and monitor the ICE Data Services Liquidity Tracker on a quarterly basis. There is also the possibility of extending the ICE Data Services Liquidity Tracker to other asset classes, including sovereign bonds, as well as creating a more granular sector based tracker.”

The tracker is based on ICE Data Services’ liquidity indicators, which are designed to provide an independent view of near-term relative liquidity, defined as “the ability to exit a position at or near the current value” of an extensive basket of securities for each market segment.

The report said the trackers suggest that liquidity in both the euro and sterling investment grade and high yield markets declined from the start of the series in April 2016.

“This is perhaps not surprising in light of the market uncertainty generated by the UK’s European Union referendum results, and the ongoing intervention of the European Central Bank and Bank of England through their respective corporate bond purchase programmes,” added Icma. “Interestingly, liquidity conditions in both the US investment grade and high yield markets improved over the same timeline, perhaps suggesting a flight to liquidity.”

Martin Scheck, chief executive of Icma, said in the report that secondary market liquidity remains a key challenge for most of the group’s members. Last summer Icma published a report, Remaking the Corporate Bond Market, analysing the state of liquidity in that segment.

Scheck said: “This has been extremely useful in discussions with those regulatory authorities who have previously concluded from academic studies that liquidity has not declined over the last couple of years. Some of these studies diverge from the findings of our market-based study gleaned both from data and from discussions with sellside and buyside market participants. Work continues.”

Icma is also part of the 17-member expert group created by the European Commission on corporate bond market liquidity under the action plan on a capital markets union. The first meeting of the expert group was held last November and the next is on 23 January.

The minutes said: “The concrete end product of the work of the group over the coming months will be a report to the Commission presenting fresh ideas on how to improve the functioning of European corporate bond markets, to be delivered in September.”

Issues raised at the first meeting included market fragmentation between regions, issuers, instruments and the role of intermediaries, particularly the reduction of risk capital from dealers, and how asset managers, hedge funds, quant funds can complement market makers.

Verena Ross, executive director of the European Securities and Markets Authority, said in a speech at the 2016 Global Capital Markets Conference in London last month that in Esma’s view, there is no conclusive evidence of declining liquidity in bond markets.

“While it is true that liquidity today is lower than it was in the years preceding the crisis, I don’t believe this is a fair comparison,” she said. “Recent research undertaken by Esma on corporate bond market liquidity could not find systematic, significant positive or negative trends in liquidity levels between March 2014 and March 2016.”

However Ross agreed that declining market liquidity can be observed during periods of high volatility and that liquidity has become more concentrated in benchmark bonds.

She continued that regulatory changes were not the only reasons for the  declining inventories of brokers and dealers and other factors include monetary policy, technological developments, the growth of the asset management industry, changes in market structure, changing risk appetites of investors, and the rise in corporate issuance. In addition regulators intended to change how  markets function following the financial crisis.

“But I am very aware that these changes will require some time and that we will need to keep a close eye on the liquidity of (corporate) bond markets. This is why expert groups at both EU level and on the global level have been set up to study this issue,” she added. “In any case, I agree that we need to have safeguards in place to avoid unintended consequences.”


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