remaking the corporate bond market · scope and methodology remaking the corporate bond market...
TRANSCRIPT
Remaking the corporate bond market
ICMA’s 2nd study into the state and evolution of the European investment grade corporate bond secondary market (2016)
ICMA Corporate Bond Market Liquidity Event, Luxembourg, November 9 2016
Andy Hill
Overview
Remaking the corporate bond market
Scope and methodology
Main conclusions of the ICMA study
What do we mean by liquidity?
Why do regulators and market participants reach different conclusions?
How the market is evolving:
the dealer model
the buy-side model
the issuer model
market structure
the official sector
Future potential challenges to bond market efficiency and liquidity
Recommendations from the study
Scope and methodology
Remaking the corporate bond market
ICMA’s second study on the state and evolution of the European IG corporate bond secondary market, published in July 2016: Remaking the corporate bond market
Partly a response to a number of official sector studies, it reviews liquidity conditions over the past 12-18 months, as well as evolution of market structure and changing behaviour and business models of various market stake-holders
Quantitative and qualitative analysis, consisting of:
Interviews with market participants
Market data
A survey of buy-side members
36 interviews with market stakeholders across the value chain, including issuers, asset managers and institutional investors, market-makers, intermediaries, and platform providers
Market data provided by relevant platforms and data providers, including ICE Data Services, Markit/Bloomberg, Tradeweb, and Trax
18 buy-side survey respondents, representing 15 firms, and €2tn AUM
Main conclusion of the ICMA study
Remaking the corporate bond market
The general perception is that market liquidity is declining – but it is more nuanced than simply things are getting worse
Over all, liquidity is becoming more challenging to provide and source
It highlights several reasons for discrepancies between official sector and market studies
Causes for this are attributed to the confluence of monetary policy and regulation
Market participants are responding the challenge, including sell-side, buy-side, intermediaries, and infrastructure providers: changing business models and behaviour
More interest in new trading protocols and e-solutions, as well as alternative products
Looking ahead, major risks seen as the ECB’s CSPP, MiFID II/R pre-trade transparency, and CSDR mandatory buy-ins [pre-Brexit]
Corporate issuers more focused than ever: concerned about a growing disconnect between secondary market liquidity and primary market efficiency
What do we mean by liquidity?
Remaking the corporate bond market
“The ability to get a price in the size you require, when you need it”?
The ability to trade without major market impact?
Can liquidity be measured?
MiFID II/R liquidity measures
ICE Data Services liquidity scores
Bloomberg’s LQA
What are the appropriate determinants?
Bid-ask spread? Market depth? Expected time to execute? Market impact? Historical volume and prints? Characteristics of instrument? Distribution of holders?
Should liquidity measures be based on trade data, or on what failed to trade?
Is liquidity dynamic, and should we expect different measures depending on market cycles as well as the life cycle of the underlying security?
If liquidity can be accurately measured, can it be commoditized?
Why do regulators and market participants reach different conclusions?
Remaking the corporate bond market
Quality and reliability of data
Aggregating data from different markets (currencies and/or security type)?
Merging different sources?
Meaningfulness of data (e.g. bid-ask spreads)?
Integrity of the models
Selecting appropriate proxies for liquidity
Discretionary use of different metrics
Interpretation of data
Bid-ask spreads: nominal tightening vs relative widening
Trading volumes: nominal trends vs relative to underlying issuance (turnover)
Dealer inventory turnover rates: increased efficiency or trading restrictions?
Immediacy measures: what traded vs what could not be traded?
Cross-referencing with qualitative outcomes and verifying assumptions and conclusions with market participants
How the market is evolving: the dealer modelThe traditional fixed income liquidity model
Remaking the corporate bond market
Market Maker
Client A
Client B
Client C
Client JClient
X
Client Y
Client Z
Provides for:
Ready two-way pricingImmediacy of execution
How the market is evolving: the dealer modelThe traditional fixed income liquidity model
Remaking the corporate bond market
Essential ingredients for the market-maker model:
Availability of capital (balance sheet) to hold long and short-positions and warehouse risk
Availability of an efficient and liquid derivatives market (such as single-name CDS) to hedge dealer positions
Availability of an efficient and liquid repo market to fund dealer positions
Skills and experience of the trader
How the market is evolving: the dealer modelThe traditional fixed income liquidity model
Remaking the corporate bond market
Undermining the market-maker model:
Availability of capital (balance sheet) to hold long and short-positions and warehouse risk
Increased cost of capital (Basel III & IV)
Volker Rule and restrictions on bank proprietary trading
Availability of an efficient and liquid derivatives market (such as single-name CDS) to hedge dealer positions
CRD IV/R, EMIR, NSFR
Availability of an efficient and liquid repo market to fund dealer positions
Leverage Ratio, NSFR,....
QE: negative rates and excess reserves
Skills and experience of the trader
Ongoing attrition of experienced staff and ‘juniorization’ of trading desks
How the market is evolving: the dealer model
Remaking the corporate bond market
Principal trader
Principal broker
Agency broker
What we lose is:
Ready two-way pricingImmediacy of execution
Changes in dealer behaviour:
Smaller inventories and faster turnoverMore considered allocation of balance sheetDeeper client engagement and awareness of needsMore specialization and focus on competitive advantageMore streamlined trading and sales desks
How the market is evolving: the buy-side modelICMA Buy-side Liquidity Survey
Remaking the corporate bond market
0%
10%
20%
30%
40%
50%
Improved Remained moreor less the same
Deteriorated Deterioratedsignficantly
General Market Liquidity (EUR)
0%
10%
20%
30%
40%
50%
Improved Remained moreor less the same
Deteriorated Deterioratedsignficantly
Liquidity for small tickets (EUR)
0%10%20%30%40%50%60%
Improved Remained moreor less the same
Deteriorated Deterioratedsignficantly
Liquidity for large tickets (EUR)
How the market is evolving: the buy-side model
Remaking the corporate bond market
Primary vs secondary
More emphasis on primary market
Buy-to-hold
More passive investment strategies
Dealer relationships
Broadening and deepening dealer relationships
Data and technology
More systematic analysis of dealer prices, axe lists, and hit rates
Price ‘makers’
Not only selecting dealers to show axes, but setting the price
Fund crossing
Increased ‘internalization’ between own managed funds
Outsourcing (‘super desks’)
Tier 2 and 3 firms sending orders to Tier 1 firms with greater access to liquidity
How the market is evolving: the issuer modelIssuer concerns
Remaking the corporate bond market
0
20
40
60
80
100
120
0
5,000
10,000
15,000
20,000
25,000
30,000
Sep
-13
Oct
-13
No
v-1
3
Dec
-13
Jan
-14
Feb
-14
Mar
-14
Ap
r-1
4
May
-14
Jun
-14
Jul-
14
Au
g-1
4
Sep
-14
Oct
-14
No
v-1
4
Dec
-14
Jan
-15
Feb
-15
Mar
-15
Ap
r-1
5
May
-15
Jun
-15
Jul-
15
Au
g-1
5
Sep
-15
Oct
-15
No
v-1
5
Dec
-15
Jan
-16
Feb
-16
Mar
-16
Ap
r-1
6
May
-16
Jun
-16
Jul-
16
€ b
illio
ns
Secondary market impact on non-financial IG corporate issuance
Eurozone EUR New Issuance (LHS) iTraxx Main (RHS)
The trend has been for buoyant primary issuance and tighter secondary market credit spreads With the credit sell-off starting late 2015, primary issuance in early 2016 reduced significantly Issuance picked up again (and spreads tightened) in response to the announcement of the ECB’s CSPP
How the market is evolving: the issuer model
Remaking the corporate bond market
There have been suggestions for possibility for fewer, larger, standardized ‘bench mark’ issues to support liquidity
But this is roundly dismissed by issuers on a number of grounds:
Issuance often relates to underlying investments or business activities
Larger issues or standardized end dates increase roll-over risk
It is expensive to sit on cash
Most European corporates do not issue regularly enough to warrant it
How the market is evolving: market structure
Remaking the corporate bond market
Electronification
Most developments based on the RFQ model (such as all-to-all RFQs)
More recent developments focused on ‘axe-driven’ rather than quote-driven ‘protocols’
So called ‘matching engines’ or ‘information networks’ are designed to put potential buyers and sellers together (including buy-side-buy-side), rather than supporting execution
Use of alternative products:
Bond ETFs
CDS indices
Bond Index Total Return Swaps
How the market is evolving: the official sector
Remaking the corporate bond market
European Commission (CMU)
Call for Evidence
Industry Roundtable on corporate bond market liquidity (July 2016)
Independent study into the drivers of corporate bond market liquidity (H2 2016)
Industry ‘Expert Group’ to look at corporate bond market (2016/17)
See Expert Group details
IOSCO
Consultation Report on Examination of Liquidity of the Secondary Corporate Bond Market
Projected study into the impacts of transparency on liquidity
See ICMA response
Other official sector studies
AMF (2015) ‘Study of liquidity in the French bond markets’
FCA (2016) ‘Liquidity in the UK bond market: evidence from trade data’
ESMA (2016) ‘European corporate bond market liquidity – recent evidence’
Future potential challenges to bond market efficiency and liquidity
Remaking the corporate bond market
MiFID II/R pre- and post-trade transparency requirements (for bonds and single name CDS)
MiFID II/R best-execution requirements
CSDR mandatory buy-ins
Even higher capital and funding costs (FRTB, NSFR)
Other miscellaneous regulatory challenges (e.g. MAR disclosure requirements)
ECB’s Corporate Sector Purchase Programme
‘Juniorization’ of the industry
Brexit
Future potential challenges to bond market efficiency and liquidity ICMA Buy-side Liquidity Survey
Remaking the corporate bond market
-5.0
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
MiFID II/R Pre-trade
transparency
MiFID II/RPost-trade
transparency
MiFID II/R BestExecution
obligations
CSDRmandatory
buy-ins
FundamentalReview of theTrading Book
Net StableFunding Ratio
QE / Monetarypolicy
Expected impact on future liquidity (EUR)+ve
-ve
Future potential challenges to bond market efficiency and liquidity ICMA Buy-side Liquidity Survey
Remaking the corporate bond market
0%
10%
20%
30%
40%
50%
60%
70%
80%
Initiatives to improve liquidity (EUR)
Decrease
Little or no impact
Improve
Significantly improve
Future potential challenges to bond market efficiency and liquidity ICMA Buy-side Liquidity Survey
Remaking the corporate bond market
0%
20%
40%
60%
80%
100%
Improve Remain more orless the same
Deteriorate Deterioratesignificantly
Liquidity: next 12 months (EUR)
0%
20%
40%
60%
80%
Improve Remain more orless the same
Deteriorate Deterioratesignificantly
Liquidity: next 12 months (GBP)
Recommendations from the ICMA 2016 study
Remaking the corporate bond market
Provide capital relief for market-making
Including related hedging and funding activity
Revitalize the single-name CDS market
Including central clearing and capital relief for CDS market-makers
Review and re-assess certain aspects of regulation
In particular MiFID II pre-trade transparency and CSDR mandatory buy-ins
Bring all market stakeholders together to review the market structure
“Only through a greater understanding and appreciation of different stakeholder needs and perspectives can the market community achieve consensus and develop private and public initiatives to maintain and grow a healthy and vibrant pan-European corporate bond market.”
Annex: Bibliography
Examination of Liquidity of the Secondary Corporate Bond Markets: Consultation Report, IOSCO, August 2016
Interaction, coherence, and overall calibration of post crisis Basel reforms, Oliver Wyman, August 2016
Addressing Market Liquidity: A Broader Perspective on Today’s Bond Markets, BlackRock, February 2016
Electronic trading in fixed income markets, BIS, January 2016
Fixed income market liquidity, CGFS Papers, No 55, January 2016
Market liquidity – resilient or fleeting? Global Financial Stability Report: Vulnerabilities, legacies and policy challenges: risks rotating to emerging markets, Chapter 2, October 2015
Global financial markets liquidity study, PWC, August 2015
Liquidity wars: Who wins and loses in the race to the bottom? Citi Research, June 2015
The Liquidity Conundrum: Shifting risks, what it means, Wholesale and Investment Banking Outlook Blue Paper, Oliver Wyman and Morgan Stanley, March 2015
The current state and future evolution of the European investment grade corporate bond secondary market: perspectives from the market, ICMA, November 2014
Market-making and proprietary trading: industry trends, drivers and policy implications, CGFS Papers, No 52, November 2014
The liquidity challenge: exploring and exploiting (il)liquidity, BlackRock, June 2014
Economic Importance of Corporate Bond markets, ICMA, March 2013
Remaking the corporate bond market
This presentation is provided for information purposes only and should not be relied upon as legal, financial, or other professional advice. While the information contained herein is taken from sources believed to be reliable, ICMA does not represent or warrant that it is accurate or complete and neither ICMA nor its employees shall have any liability arising from or relating to the use of this publication or its contents.
© International Capital Market Association (ICMA), Zurich, 2016. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without permission from ICMA.
Contact: [email protected]
Remaking the corporate bond market
The report: Remaking the corporate bond market, ICMA, July 2016
http://www.icmagroup.org/assets/documents/Regulatory/Secondary-markets/Remaking-the-Corporate-Bond-Market-250716.pdf
The author: Andy Hill, Senior Director, [email protected]+44 (0)20 7213 0335