Will Regulation Cause a Liquidity Crisis?

Shanny Basar

Concerns about the unintended consequences of regulation and a potential liquidity crisis were the main themes at the MarketAxess and Trax European Capital Markets Forum in London yesterday.

Debate raged over whether regulatory changes which have led to a shrinking of bank balance sheets, and a decrease in market making, has made the system more unstable and so will lead to a liquidity crisis in times of extreme stress. Some panellists argued that the issue is not a  lack of liquidity, but the plumbing that needs to to be put in place to allow investors to access new pools of liquidity, such as all-to-all trading, and for the buyside to make prices.

Consultancy Greenwich Associates said in a recent report, Innovations Ease Corporate Bond Trading, that 48% of buyside bond traders are bullish on all-to-all trading. An all-to-all model allows multiple parties in a network to come together to trade rather than the traditional model of only banks supplying liquidity to the buyside. Last month Tradeweb Europe said it will be introducing all-to-all trading on its credit platform in the region in second half of this year. The electronic fixed income, derivatives and exchange-traded fund venue had already announced the launch of all-to-all trading on the US credit platform. MarketAxess reported last month that volume on Open Trading, its all-to-all market for corporate bonds, rose to a record $59bn in the first quarter, with average daily volume up 56% with the first quarter of last year.

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A panel on new market opportunities discussed the growth of fixed income exchange-traded funds in Europe and their impact on liquidity. Assets invested in ETFs/ETPs listed globally broke through the $4 trillion milestone at the end of last month according to ETFGI, an independent research and consultancy firm. In addition, in the first quarter of this year ETFs listed in Europe reached a record $640bn is assets. There were net inflows of $7.8bn into fixed income products during that period, lower than the net inflows of $9.2bn in the first three months of last year.

Panellists also debated whether the new pre-trade and post-trade transparency requirements for MiFID II, the regulations coming into force in the European Union from 2018, will make it easier to find liquidity.

The conference learnt that the European Securities and Markets Authority is due to release further Q&As on detailed specifications for MiFID II “soon”. The post-trade panel also discussed the MiFID II reporting requirements:

The opening keynote speech was from Sebastian Mallaby, author of  The Man Who Knew: The Life & Times of Alan Greenspan, which topically covered how the Federal Reserve in the 1970s fought to maintain its independence against a hostile administration.

Mallaby said the next recession will be caused by a financial crisis, from a crash in overvalued assets, rather than an inventory crisis. In addition, his discussions with central bankers indicate that growing debt in Italy is the biggest threat to the Eurozone and the global economy:

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