FCA under fire for ‘dangerous’ bond report

The occasional paper, published last week, acknowledged bond markets “pose specific liquidity challenges for investors”, but asserted liquidity in the UK corporate fixed income space had not decreased following the financial crash. It also said regulatory interventions had not made conditions worse.

However Chris Bowie, who manages the £210m TwentyFour Corporate Bond fund, accused the FCA of trying to “re-write history”, called the paper “dangerous” and said it did not “tell the real story”.

Mr Bowie claimed the paper’s findings were at odds with fixed income managers’ experience, adding it was hard not to be cynical about the paper and that comments regarding regulatory interventions showed the publication’s “real motivation”.

“Unfortunately, as fixed income portfolio managers, our day-to-day trading experience has been the polar opposite of this academic theory,” he said.

The publication, written by Matteo Aquilina and Felix Suntheim, who work in the FCA chief economist’s department, noted there had been “no corresponding drop in liquidity in the UK’s £2.5tn corporate bond markets”.

This was despite the amount held in corporate bonds by UK dealers falling from £400bn in mid-2008 to just £250bn at the end of 2014, according to transaction data.

“In fact, aside from a relatively brief period immediately after the crisis, illiquidity has been decreasing to very low levels,” they added.

“In numerical terms, roundtrip costs – a reliable indicator of liquidity – had declined from a peak of around 0.5 per cent in 2009, to 0.1 per cent at the end of 2014.”

Mr Bowie questioned the usefulness of the data studied and said using it missed the “key point” that illiquidity meant transactions had not occurred. He said the dataset was too narrow, using a universe with only 409 bonds, 92 per cent of which were financials, compared to the 40 per cent weighting in most indices.

“Truthfully, how relevant is such a narrow universe? I can understand the paper’s conclusions from the specific, narrow data that they used – but that data set does not tell the real story,” he said.

“And to claim that in fact liquidity has gone up is incredibly unhelpful and could arguably be dangerous. Dangerous to the extent that if it implies a level of liquidity for investors that leads to asset allocation shifts, and that liquidity inference does not match the reality, then investors could end up paying a higher price than they expected.”

Mr Bowie said TwentyFour had challenged the FCA paper’s authors to spend a day at the firm trading credit so they can “witness first-hand the difference between theory and practice.”

He cited an experience in the last week where in search of bonds of an insurance company, he only found one broker holding inventory and offered at such a price as he would enact a loss in his portfolio.

“This is the reality of life at the coalface, and this is not even considered in the FCA’s occasional paper. This is where real world experience counts over academic certainties,” he said.