International Capital Market Association ICMA
IC ICMA and bond market evolution • ICMA’s European corporate bond liquidity study • Electronification of bond markets in Europe Liz Callaghan ICMA
ICMA’s European corporate bond liquidity study 1
ICMA 2016 corporate bond market study In 2014 , ICMA was asked by the buy-side to investigate the state of play in corporate bond markets and the possible cause or causes of the liquidity challenges. • November 2014 - ICMA released the first study on corporate bonds: The current state and future evolution of the European investment grade corporate bond secondary market: perspectives from the market. – Semi-structured interviews, allowing participants to focus on issues or topics of most relevance to them. The market participants interviewed (investors, issuers, banks and broker- dealers, intermediaries and e-trading platform providers) considered the liquidity impairment largely attributed to the unintended consequences of banking regulation and extraordinary monetary policy. – The study discussed and acknowledged the increasing concern that European credit bonds had become critically impaired and were not functioning effectively or efficiently. – The causes were complex, but the major impact was the reduction in the capacity, or willingness, of broker-dealers to fulfil a market-making role. At the time, many respondents expressed concern about how this could play-out under more stressed market conditions, and the potential broader economic implications. Frozen capital markets? Risks to economic growth? Prospect of another financial crisis? 2
ICMA 2016 corporate bond market study In 2016, ICMA was asked to investigate how the market has evolved since the previous study. • July 2016 – ICMA released the 2nd study into the state and evolution of the European investment grade corporate bond secondary market: Remaking the corporate bond market ꟷ Scope & Methodology: Unlike the previous report, which was largely based on a series of in- depth interviews with market participants (investors, issuers, banks and broker-dealers, intermediaries and e-trading platform providers), the 2016 report relies on both qualitative and quantitative input (interviews, market data, a survey of buy-side members from these market participants. ꟷ Cause: Market participants report that in the current environment it continues to be more challenging both to provide and source liquidity. The cause is primarily the result of interaction of various regulatory initiatives and extraordinary current and future monetary policy, and the undermining of the market-making liquidity model, largely due to greater capital constraints on banks and broker-dealers. ꟷ Impact: Increasingly difficult to trade in large sizes, to execute orders quickly, or to establish reliable prices. ꟷ Result: Market participants are more resolved to adapt to the new norm, and are evolving their business models accordingly. While sell-side firms continue to reshape their models around balance sheet efficiency, acting more as principal brokers than market-makers, the buy-side is taking more initiative in terms of locating and creating liquidity. Technology is playing an increasingly important role in the market. 3
ICMA 2016 corporate bond market study What do we mean by liquidity? “The ability to get a price in the size you require, when you need it” “The ability to trade without major market impact” Sometimes there are more questions than answers: • 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? • Can liquidity be measured? • MiFID II/R liquidity measures • ICE Data Services liquidity scores • Bloomberg’s LQA • 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? 4
ICMA 2016 corporate bond market study ICMA Buy-side Liquidity Survey Liquidity: next 12 months (EUR) 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Improve Remain more or Deteriorate Deteriorate less the same significantly Liquidity: next 12 months (GBP) 80% 70% 60% 50% 40% 30% 20% 10% 0% Improve Remain more or Deteriorate Deteriorate 5 less the same significantly
ICMA 2016 corporate bond market study ICMA Buy-side Liquidity Survey Initiatives to improve liquidity (EUR) 80% 70% 60% 50% 40% Decrease 30% Little or no impact Improve 20% Significantly improve 10% 0% 6
ICMA 2016 corporate bond market study Main conclusion of the ICMA study 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 7
ICMA 2016 corporate bond market study Recommendations from the ICMA 2016 study 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 aspect 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.” 8
Ele lectronif ification of bond markets in in Europe 9
Electronification of bond markets Evolutionary “triggers”: Regulatory pressures (including MiFID II and Basel III) are transforming trading practices and today are one of the leading contributors to the altering state of the market. Technology is speeding up the change in fixed income trading and represents the other leading contributor to the changing shape of bond market trading. • Technology is starting to create a more efficient, rationalised model of trading, and some say ‘smarter’. • The key driver for the technology development is the liquidity challenges experienced within the buy-side trading community. 10
Key facets of electronic trading evolution: Fixed Income vs. Equities: • The key element to point out is that equities is more about electronic trading - speed e.g. HFT. Whereas, fixed income is more about the ‘automation’ or ‘optimisation’ of trading e.g. sourcing, aggregating and datamining. Regulatory pressures such as MiFID II is a major catalyst for change: • MiFID II concerns the framework of trading venues and structure in which instruments are traded. MiFIR on the other hand, concentrates on regulating trading venues and structuring its operations. So, ‘who’ the market structures are, ‘what’ they trade and ‘how’ they are traded. Fixed Income trading must adapt and innovate. • This will involve all facets of trading including people, technology and a re-direction of business strategy. The bond trading eco-system will see new possibly disruptive entrants, innovative incumbents and adaptive trading protocols and venues. 11
Key facets of electronic trading evolution: Fixed Income vs. Equities Equities: Bonds: • Equity Instruments – 6,810 shares • Over 150,000 debt securities (contained admitted to trading on regulated in Trax’s Computer Updated International markets in the EU, on average trade Database [CUPID]), on average trade 1.5 400 times per day. times per day. • Commission based. • Quote driven relying on RFQs. • Order driven with Straight Through • Different characteristics – each bond can Processing (STP), using FIX protocol have a different maturity, coupon and enabling full end-to-end trading with rating. audit trail. • Heavy use of OTC Markets with market • DMA to exchanges using bank’s making and balance sheet usage. pipes and plumbing. • Heavy use of IDBs. • Heavy use of algorithmic trading for electronic statistical and rules based ( Biais and Declercq - Academic Study, 2007 and ICMA published trading in an agency environment. article 2009) 12
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