More innovative ways of trading corporate bonds may be needed to tackle the lack of liquidity in the market, according to the executive director of the European Securities and Markets Authority.
Verena Ross said that investment banks, the buy-side and investors are all looking for alternative ways of trading corporate bonds.
She said: “Initiatives by market participants and technology providers to develop new trading technologies and electronic platforms multiply.
“While some initiatives, like ‘all-to-all’ trading platforms, focus on reducing the role of the middleman, i.e. the bank, others, like Honeycomb, aim at improving pre-trade information.”
She explained that these developments are interesting as they may help re-introduce liquidity in the market.
“Yet, more time and scrutiny might be needed before they can effectively be considered as a replacement to the traditional Request for Quote trading model.”
Jean-Paul Servais, president of Belgium’s Financial Services and Markets Authority, said the lack of liquidity could translate into higher liquidity premiums and borrowing costs and affect the stability of the financial system in case of shocks.
“Innovative ways to bring together potential buyers and sellers and to increase transparency in the market are therefore needed.”
The FCA has said it is monitoring developments in liquidity issues for corporate bonds “carefully”.
It has been suggested that the reported decline in market liquidity is due to dealers becoming less willing to trade corporate bonds and other fixed-income securities due to the additional costs of holding them on their balance sheets.
This has led to a fear that if asset managers began to sell these securities, then prices could fall sharply.
Jim Leaviss, head of retail fixed interest for M&G, pointed out liquidity risks remain high, as the corporate bond market asset growth has been accompanied by a shrinking of the investment banks’ ability and willingness to hold bonds on their balance sheets.
“We believe investors need to be compensated for both credit and liquidity risk, and to run more in cash and liquid fixed income instruments than they might want to purely from an investment standpoint.”
Regultor view
A spokesman for the FCA said: “We are carefully monitoring developments in liquidity in corporate bond markets.
“Electronic systems that facilitate ‘all-to-all’ trading of corporate bonds may help to enhance liquidity, as a supplement to dealer-intermediated trading. We welcome market developments in this regard.
“Appropriate rules on price transparency are also important. The availability of reliable price information can enhance willingness to trade and thereby sustain liquidity. But for less liquid instruments, aggressive price transparency requirements may reduce the willingness of market makers to offer prices. Transparency rules are being enhanced as part of Mifid II.”
