IOSCO published a report that examines the factors affecting liquidity, under stressed conditions, in the secondary corporate bond markets. The report notes that changes in the structure of secondary corporate bond markets have altered the way that liquidity is provided in these markets. These changes result from things such as post-crisis regulations that have reduced the capacity of intermediaries to provide liquidity in secondary corporate bond markets, greater risk aversion on part of intermediaries, gradual introduction of electronic trading, and significant growth in the size of these markets resulting from central banks’ quantitative easing policies and low rates of return on other financial assets.
The report is prepared by an IOSCO committee on emerging risks. The findings of this report are drawn from a review of the literature on liquidity in corporate bond markets under normal and stressed conditions, an examination of past episodes of stress in corporate bond markets, and discussions with a broad range of industry stakeholders. The key findings of the report include:
- The structure of corporate bond markets has evolved since the financial crisis, driven primarily by changes in the behavior of market intermediaries and in the supply of and demand for corporate bonds.
- A reduction in the capacity and desire of dealers to participate in corporate bond markets as principals could mean that future movements in bond prices in times of stress will be more acute than before.
- Several characteristics of corporate bond markets should reduce the risk that strong price movements in bond markets will generate broader economic stress. These include effective liquidity management by issuers of corporate debt, reduced leverage and fewer leveraged players in the market than before the financial crisis, and the low frequency with which many corporations enter primary bond markets for financing.
- The willingness, resources, and ability of market participants to provide sufficient demand-side liquidity to help stabilize markets will be critical factors in determining how corporate bond markets operate under stress.
- Mutual funds are unlikely to be a source of either considerable selling or price volatility under stress, particularly those funds with managers who have instituted strong liquidity management processes, including plans for operating under stressed conditions.
Overall, significant structural changes that have taken place in corporate bond markets since the 2008 financial crisis and the ensuing financial reforms have likely reduced the ability of traditional liquidity suppliers to lean against the wind. Intermediaries reduced their supply of liquidity and increased the number of agency-based transactions they conduct for their clients relative to the principal-based transactions, in both normal times and times of stress. On the positive side, asset managers, including managers of mutual funds, appear to recognize the problem and believe they have liquidity risk management arrangements that should allow them to handle an increase in redemption requests from their clients, without having to conduct ‘fire sales’ of their corporate bond assets.
Keywords: International, Banking, Securities, Post-Crisis Regulation, Corporate Bonds, Market Liquidity, Liquidity Risk, IOSCO
Previous ArticleOSFI Proposes Guideline on Internal Model Oversight for Insurers
Next ArticleBCBS Publishes Summary of the Meeting in June 2019
FCA and PRA in the UK, FED in the US, and the authorities in Singapore have fined Goldman Sachs for risk management failures in connection with the 1Malaysia Development Berhad (1MDB).
BCBS announced that OSFI and the Bank of Canada hosted the 21st International Conference of Banking Supervisors (ICBS) virtually on October 19-22, 2020.
FCA proposed guidance on how firms should continue to seek to help customers who hold insurance and premium finance products and may be in financial difficulty because of COVID-19, after October 31, 2020.
EBA issued an opinion on prudential treatment of the legacy instruments as the grandfathering period nears an end on December 31, 2021.
ESRB published the fifth issue of the EU Non-bank Financial Intermediation Risk Monitor 2020 (NBFI Monitor).
HM Treasury announced that the new Financial Services Bill has been introduced in the Parliament.
APRA announced that it has increased the minimum liquidity requirement of Bendigo and Adelaide Bank for failing to comply with the prudential standard on liquidity.
PRA published the consultation paper CP17/20 to propose changes to certain rules, supervisory statements, and statements of policy to implement elements of the Capital Requirements Directive (CRD5).
US Agencies adopted a final rule that applies to advanced approaches banking organizations and aims to reduce interconnectedness in the financial system as well as to reduce contagion risks associated with the failure of a global systemically important bank (G-SIB).
US Agencies (FDIC, FED, and OCC) adopted a final rule that implements the net stable funding ratio (NSFR) for certain large banking organizations.