UK watchdog paper says bank rules have not hit bond market liquidity

2 min read
EMEA
Huw Jones

(Reuters) - The ability of investors to buy and sell corporate bonds has actually improved, not declined, in recent years, a paper published by Britain’s markets regulator said on Thursday which undermines calls from banks for a regulatory pushback.

Bond markets’ ability to absorb heavy selling has become a major topic of debate between banks and central banks following “taper tantrums” or huge volatility in bond markets.

Banks argue that higher capital charges on bond inventories introduced since the 2007–09 financial crisis mean that it is no longer economic to hold the amounts of bonds needed to offer a market at all times to investors.

The paper, written by two of the Financial Conduct Authority’s (FCA) staff for discussion, said dealers in Britain held £400bn (US$578bn) worth of bond inventories in mid-2008, but that fell to £250bn at the end of 2014.

The decrease, however, did not imply a reduction in liquidity, the paper said.

“We also document that there is little evidence that liquidity is having a larger effect on bond spreads now than a few years ago,” the paper said. “If anything, the market has become more liquid in recent years.”

The findings carry weight as the FCA is a member of the Bank of England’s Financial Policy Committee, which has been scrutinising liquidity in bond markets and whether action is needed.

The European Commission, separately on Thursday, asked EU regulators to rethink new bond market rules after concerns they could damage liquidity.

Regulators globally, however, have said so far that the jury is out on whether they need to intervene by scaling back capital charges, saying other factors could be affecting liquidity, such as shifts to electronic trading.

“The regulatory interventions that have been introduced since the financial crisis did not result in less liquidity in normal times and did not result in liquidity being more ‘flighty’ when shocks of a mild nature hit the system,” the FCA paper said.

The structure of the UK corporate bond market has not changed markedly in the last eight years, with 90% of trades done “off-exchange” or privately, the paper said.

Bank of England Governor Mark Carney also heads the global Financial Stability Board, which is due to report in coming months on its studies into bond market liquidity.

The FCA told asset managers in February they must review how they would cope with widespread redemptions or investors pulling out money en masse in stressed markets.

The logo of the new Financial Conduct Authority (FCA) is seen at the agency's headquarters in the Canary Wharf business district of London