ICMA secondary credit market study:
meeting the liquidity challenge
Amsterdam, November 10th 2015
Andy Hill
ICMA secondary credit market study
Corporate bond markets and the real economy
“Corporate bond markets can be considered an important ingredient in economic growth,
financial stability and economic recovery, particularly in the wake of the crisis. They provide
a key capital funding flow to firms allowing them to expand, innovate, offer employment,
and provide the goods and services societies demand.”
- IOSCO, 2014, ‘Corporate Bond Markets: A Global Perspective
ICMA secondary credit market study
The current state and future evolution of the European investment grade corporate
bond secondary market: perspectives from the market
ICMA secondary credit market study
Key-themes coming out of the study
The death of liquidity
Changing business models
Market transparency
Electronification of the market
The issuer perspective
The risks from future regulation
The next crisis?
Meeting the liquidity challenge: re-liquefying the corporate bond market
ICMA secondary credit market study
What do we mean by liquidity
“Liquidity is the ability to get a price in any instrument, in any size, at any time.”
- Fund manager
Means different things to different participants
2002-2007 a liquidity bubble? [CDS/structured derivatives]
Dynamic (market cycles and bond life cycles)
Quantifiable? As much a state as a measure
“The golden age of liquidity was a very brief period, and driven by leverage.”
- Credit trader
ICMA secondary credit market study
The death of liquidity
“The main issue facing the investment grade Eurobond markets today is the lack of
liquidity.”
-Fund manager
Overarching theme
Basel III capital requirements; leverage ratios; EMIR, Volcker
Market conditions (QE, low rates, low volatility, tight credit spreads)
No markets in size: more agency broking (an excuse?)
Corporate bond markets inherently not liquid
ICMA secondary credit market study
The market-making model for fixed income
The four key ingredients:
Balance sheet
A functioning and liquid derivatives market
A functioning and liquid repo market
Expertise
ICMA secondary credit market study
The market-making model for fixed income
Breaking the model:
Balance sheet
 Basel III capital ratios
A functioning and liquid derivatives market
EMIR
A functioning and liquid repo market
 Basel III leverage ratio
Expertise
 Attrition and ‘juniorization’
ICMA secondary credit market study
Changing business models – broker-dealers
“The sell-side used to give liquidity away for free; now, if the buy-side wants it, they should
pay for it”
- Credit trader
 Better balance sheet allocation and focus on risk-weighted return on capital
 Reduced inventories, more client/axe focused (commission based model?)
 More niche players / specialization
 Down-sizing and down-grading of bank broker-dealers
ICMA secondary credit market study
Changing investor behaviour
“Investment managers may become driven more by liquidity considerations, rather than by
valuations or investment strategies”
- Fund manager
 Splitting orders
 Internalized liquidity
 Primary markets as source of liquidity
 Buy-and-hold (increased due diligence)
 Less liquid investments (‘hunt for yield’)
 More use of derivatives / ETFs
ICMA secondary credit market study
The issuers perspective
“We have enjoyed good market conditions; there is a lot of cash around, it is difficult to be
overly concerned”
- Corporate issuer
Market has been good, but issuers becoming increasingly concerned
Secondary markets help price primary issuance
Selection of banks to award lead manager mandates?
Standardized issuance?
ICMA secondary credit market study
The risks from future regulation
 MiFID II/MiFIR: pre and post trade transparency requirements
 The winners curse (the transparency paradox)
 Confusion between transparency and liquidity
 Draft RTS seem much better than originally feared
“Transparency is fine for retail trades, but it will kill the wholesale market”
- Credit analyst
CSDR: mandatory buy-ins



A solution looking for a problem
The end of short-selling
ICMA CSDR Mandatory Buy-in Impact Study (Feb 2015)
“Mandatory buy-ins will be the final nail in the coffin of market liquidity”
- Credit trader
ICMA secondary credit market study – meeting the liquidity challenge
The next crisis?
“This is a classic bull market; valuations have gone out the window”
- E-platform provider
A common thread in the various discussions with all participants is the inevitability of the
meltdown in global credit markets.
Regulation has shifted risk from banks to investors.
While market cycles are nothing new, the common concern is that, largely because of
regulation, financial markets have never been worse placed to deal with a sharp
correction.
A combination of larger bond markets, with fewer, larger investment firms, and a
weakened capacity for bank intermediation, all makes for the perfect storm.
While some see the lack of liquidity in the secondary markets as exacerbating any
correction, others are more concerned about how a non-functioning secondary market
could impede any return to normality.
ICMA secondary credit market study – meeting the liquidity challenge
Re-liquefying the corporate bond market
 Electronification of the market
 Buy-side initiatives
 Issuer initiatives
 Better regulation
ICMA secondary credit market study – meeting the liquidity challenge
Electronification of the market
“When liquidity does come back, there will be fewer people and more technology”
- E-platform founder
Increase in use, and expected to grow with more entrants
Improved scope for connectivity and new protocols (‘all-to-all’ /‘buy-side-to-buy-side’)
Big data to support more ‘intelligent’ broking models
Virtual liquidity (or ‘liquidity sourcing’)
A replacement for market-making?
ICMA secondary credit market study – meeting the liquidity challenge
Re-liquefying the corporate bond market
Buy-side initiatives





Internalized liquidity
Price-makers
Redemption gates
ETFs and derivatives
But: is it the responsibility of the buy-side?
 Issuer initiatives
 More selective awarding of mandates
 Standardized issuance (‘benchmarking’)
 But: is it the responsibility of issuers?
Better regulation
 Winners and losers?
 Functioning and efficient markets a social good
 Connection between market regulation and real economy
ICMA secondary credit market study – meeting the liquidity challenge
Conclusion
The interviews for this study suggest that the European investment grade credit market is
a dramatically changing landscape.
Liquidity, by most definitions, is rapidly evaporating, primarily as a result of financial
regulation and extraordinary monetary stimulus.
Banks and investors are adapting to the new environment, as are electronic
intermediaries who are looking to provide possible solutions. Issuers, as yet, are relatively
unaffected, but are becoming increasingly concerned.
While a number of market led solutions are being discussed, at some stage the impact of
regulation on market liquidity and efficiency will need to be considered, not least as the
role of capital markets in supporting economic growth comes ever more into focus.
ICMA secondary credit market study – meeting the liquidity challenge
Conclusion
Ultimately, if the challenges facing the corporate bond secondary markets are to be
addressed and solutions found this will require the constructive and coordinated effort of
all stakeholders: market-makers, investment managers, trading platforms and
intermediaries, the issuers, and the various regulatory bodies and authorities.
Functioning and efficient capital markets are a social good that support economic activity
and growth. For those who provide, use, and oversee capital markets, this should be a
collective responsibility.
ICMA secondary credit market study – Annexes
ICMA Secondary Market Practices Committee (SMPC)
 Open forum for sell-side and buys-side members active in the European high grade
corporate bond market.
 Key functions:
i.
ii.
iii.
iv.
Agreeing best practice for the corporate bond secondary market.
Maintaining and developing the ICMA Rules and Recommendations for the secondary
market (‘The ICMA Rule Book’) to ensure that they remain relevant and consistent with
regulatory requirements.
Leading initiatives to improve corporate bond secondary market liquidity and efficiency.
Providing a forum for discussing the likely impact of relevant regulation on secondary
market practices, and for consolidating input and feedback in the regulatory consultation
process.
 Three sub-committee working groups: (i) MiFID II/R WG; (ii) CSDR/Buy-ins WG; (iii)
Electronic Trading WG
ICMA secondary credit market study - Annexes
About the author/presenter
 Andy Hill is a Director in ICMA’s Market Practice and Regulatory Policy group. For
seventeen years he has been a repo and money-market trader, and for ten years he was
an Executive Director at Goldman Sachs. He has also worked as a consultant in the Aid
and Development sector, primarily based in Cambodia, and previously served on the
Board of the Cambodian NGO Education Partnership in Phnom Penh while under a
Goldman Sachs Public Service Fellowship. He holds a BSc (Hons) in Business Studies from
Cass Business School and an MSc in Poverty Reduction and Development Management
from the University of Birmingham.
 Email: andy.hill@icmagroup.org