IOSCO: “No meaningful decline” in secondary bonds liquidity

Perceptions that liquidity has dwindled in secondary bonds market are at odds with empirical data, according to global securities group

There is currently no evidence to support the view that liquidity in the secondary corporate bonds market has declined from historic, non-crisis norms. That’s the message of a new report from the International Organisation of Securities Commissions (IOSCO).

In its study of the secondary bonds market between 2004 and 2015, IOSCO examined a wide range of data sources, reviewed academic and government research from around the world and carried out its own consultation.

Some 68% of that consultation’s respondents said that they believed liquidity in the secondary bonds market had deteriorated from 2004 to 2015 – albeit acknowledging that they lacked objective data to measure that perceived slump.

Among sell-side participants, the figure was even higher, with 80% convinced that liquidity had dwindled. Again, this was based upon overall experience rather than any rigorous analysis of hard data.

As the report points out: “Corporate bond issuances have reached record highs in most IOSCO member jurisdictions.

“The growth in the primary market has increased the number of corporate bonds available for trading in the secondary bond markets and the total amount of debt outstanding.”

One reason for this, says the report, is the low interest rate environment – which in many jurisdictions has resulted in near-zero interest rates for almost seven years.

That environment, it notes, “has indirectly incentivised investors to buy assets such as corporate bonds in the hunt for yield as a result of low interest rates and other central bank policies, such as quantitative easing.”

Many traditional dealers told IOSCO that due to a combination of strategic, capital and regulatory factors, they have adjusted their business models to decrease the size of their balance sheets.

As such, dealer corporate bond inventories are not keeping pace with the number of bonds available for trading in the secondary corporate bond markets.

“However,” the report stresses, “rather than a sign of illiquidity, this shift may partially reflect the traditional dealers’ transition away from a principal model to an agency model, which does not require them to hold large amounts of corporate bonds on their balance sheets.”

Certain dealer representatives expressed the view that regulatory requirements – for example, higher capital and leverage requirements – have reduced dealers’ ability and willingness to:

  • allocate capital to proprietary and market-making activities;
  • hold positions (particularly large inventories) in corporate bonds over time; and
  • actively trade corporate bonds.

Consequently, they believe that the resulting decline in the breadth of participation on the sell side is a likely contributor to the sense of illiquidity that is currently perceived by some buy-side market participants.

Furthermore, says the report, “a number of dealer respondents perceive that, since the global financial crisis, there has been a decrease in participation by dealers in the secondary corporate bond market.

“They say that dealers who provided liquidity in the past have exited market-making activities altogether – which could impact market liquidity, as there is a negative correlation between the number of market makers and the liquidity risk premiums.”

As IOSCO sought to identify commonalities across jurisdictions, certain themes stood out. Chief among them was that in developed markets, particularly in Europe and the US:

  • dealer inventories may have decreased from pre-2008 crisis levels;
  • market structures have changed; and
  • dealers in some territories may be less motivated to make markets than they once were.

“Nonetheless,” the report says, “IOSCO’s holistic approach in identifying and analysing numerous metrics to assess liquidity – including recognising the strengths and weaknesses of individual metrics – led us to the ultimate conclusion that… from a macroeconomic perspective, there is no substantial evidence showing liquidity has deteriorated markedly from historic norms for non-crisis periods.”

Read the full report here.

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