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 ArticleBOE Article Explains Process for Bank Authorization in UK
BIS and BoE launched the BIS Innovation Hub Center in London, which is the fourth new Innovation Hub Centre to be opened in the past two years.
ESRB published recommendations on the reciprocation of macro-prudential measures in Belgium, France, Luxembourg, Norway, and Sweden.
EC published the Delegated Regulation 2021/931, which supplements the Capital Requirements Regulation (CRR or Regulation 575/2013) with regard to the regulatory technical standards specifying the method for identifying derivative transactions with one or more than one material risk driver.
BCBS is consulting on preliminary proposals for the prudential treatment of cryptoasset exposures of banks.
EBA issued a revised list of validation rules under the implementing technical standards on supervisory reporting.
BIS Innovation Hub, BDF, and SNB announced that, together with a private-sector consortium led by Accenture, they will conduct an experiment using wholesale central bank digital currency (wCBDC) for cross-border settlement.
ESAs published two amended implementing technical standards on the mapping of credit assessments of External Credit Assessment Institutions (ECAIs).
EBA published revised guidelines on major incident reporting under the Payment Service Directive (PSD2).
BCBS updated the year-end and annual average exchange rates in context of the global systemically important bank (G-SIB) assessment exercise.
HKMA issued a circular informing the industry about its intention to revise the target effective dates for the revised frameworks on credit risk, operational risk, output floor, leverage ratio, market risk, and credit valuation adjustment risk.