Where are we of liquidity in the bond markets?

In the years that followed the 2008 financial crisis,

In the years that followed the 2008 financial crisis, several episodes of high volatility on European bond markets or Americans reminded that liquidity, within the meaning of the ability to perform immediately, and at a low cost of large transactions, without significant impact on the price, is far from back to the level of before crisis. This subject remains topical and concern as well for investors, banks that regulators.

Liquidity issues are very different, depending on whether talking about the debt of State or corporate debt. Our analysis in this paper will be on the latter.

Functioning of the market

Unlike the equity markets that are driven by orders and are to meet buyers and sellers, the bond markets, because of the heterogeneity of emissions, require market makers (market makers). They must be able to propose prices for the purchase and sale of securities to ensure the liquidity of the market. In playing this role, banks assume the risk of holding of securities in their balance sheet, and pay on the difference ofcourse between the acquisition and resale of the title. This difference is linked to the evolution of the spread of credit of the issuer and the portage during the period ofdetention of the title (accrued coupon).
A regulatory framework that pushes banks to no longer play the role of market maker…
Gold, banks, pushed by the Basel requirements in terms of solvency and liquidity (detention of titles of high quality for the purposes of the CRL) and by a lower appetite for risk, invest less in less liquid securities, such as corporate high yield bonds, andconcentrated their investments in safe assets and strong liquidity, as well as an advantageous credit weighting like the sovereigns of the economies developed.
.. .in a low rate environment…
The disengagement of banks in markets for corporate bonds, where their role as providers of liquidity is vital, accompanied a surge in bond issuance businesses. Indeed, companies took advantage of low rates and the high demand for performance-hungry institutional investors, to fund itself cheaply. In Europe, where the business financing is still largely based on banks, their stock rose from 800 Md€ in 2010. at 1100 Md€ in 2015. In the United States, where the financing on bond markets is more accessible and more prevalent, the increase is also important. Stocks have thus reached 12500 Md$ in 2014, an increase of 41% compared to 2010.
.. .and of indicators that announced a “liquidity” in the market
There is no absolute measure of liquidity indicator. Nevertheless, the combination of indicators such as turnover (average aggregate monthly trading volume divided by the outstanding), spread bid – ask, or the average volume of transactions may reflect a tendency of liquidity in the bond markets that should be to analyse.
Hand, on European corporate debt markets, this last flag is passed 1 m € in 2010 toless than 0.6 M€ in 2015, suggesting the increasing difficulty of the market players to execute large volumes. On the other side, an article [1] published by the bis showsthat if turnover decreased significantly on the markets of the corporate bonds of several countries, including the United States, the bid – ask spread, has known, without recovering the levels of 2006-2007, a significant tightening since the peak in 2008.
The contrast suggested by the various indicators of liquidity is not one. Indeed, themassive interventions by the central banks, and most recently the ECB, allow, for the time being, to keep afloat the bond markets. However, the rise of rates, initially in the United States, then surely in the wake in Europe, can constitute a real risk of drying up of liquidity.
The mutual funds, equivalent U.S. CPF now hold 20% [2] of the American corporatebonds. These funds offer investors the opportunity to daily redemption of their shares. As a result, a flight to quality of these funds, or a significant increase in redemptions, following the rise in rates could push to massive sales of bonds held, and to create, in the context of disengagement banks an imbalance between buyers and sellers for damaging for liquidity.
What prospects to improve liquidity?

The rise in rates in the United States, then in Europe could be an opportunity to further highlight the fragility of the bond markets. In this context, the banks argue for an easing of regulations on market-making activities.

Furthermore, alerted by the deterioration of the liquidity several asset managers have joined the banks, to create electronic trading platforms that offer to meet buyers and sellers [3]. The craze is very strong, because of the transparency of prices, and low transaction costs. These initiatives are still fragmentary, concern a small number of standardized obligations and are based ultimately on market traditional makers.
Current tensions and the risk of drying up of liquidity, which weigh on corporate bond markets show, of course, that banks have an important role to play, not be completed by electronic trading platforms. But above all, they defeated breached the illusion of liquidity, which remains fragile, and far from being acquired. Prudential requirements implemented and future renchériront the cost of liquidity. Investors should be aware, and require a fair remuneration for illiquidity.