IOSCO Requests Comments on Study of Liquidity in Corporate Bond Markets

IOSCO requested comments on a consultation report reviewing liquidity issues in the secondary corporate bond markets. The study found no reliable evidence that liquidity in these markets deteriorated markedly from historic norms for non-crisis periods.

According to IOSCO, industry perceptions of the development of bond market liquidity between 2004 and 2015 are mixed but “the majority of both buy-side and sell-side respondents to the IOSCO survey perceive market liquidity to have decreased.” The report stated “these perceptions were generally based on personal experience and not supported with data or data analysis.” IOSCO stated, however that “[w]hile some of the relevant metrics (turnover ratio, dealer inventories, and block trade size) might indicate potential signs of lower liquidity, most metrics reviewed show mixed evidence of changes in liquidity (bifurcation of trading, average trade size, and average number of counterparties or market makers) or some evidence of improving liquidity (trading volume, bid-ask spreads, and price-impact measures).”

IOSCO noted that:

 . . . there is no reliable evidence that regulatory reforms have caused a substantial decline in the liquidity of the market, although regulators continue to monitor closely the impact of regulatory reforms.

IOSCO requested comments from market participants on the conclusion that bond market liquidity has not substantially declined. IOSCO also requested information about:

  • specific dealer inventory levels (gross and net) of corporate bonds held for the purpose of market making in corporate bonds, between 2004 to the present date;
  • statistics concerning dealer quoting behavior;
  • the number of counterparties that various buy-side and sell-side firms are trading with;
  • orders that investors tried to execute but could not do so for various reasons; and
  • the time it takes participants to execute trades in secondary corporate bond markets.

Comments on the report must be submitted by September 30, 2016.

Lofchie Comment: Market participants are adamant that liquidity has declined. Regulators are adamant that liquidity has not declined or that, if it has declined, it is because of factors other than regulatory change. Who, then, is one to believe? Consider this: the regulators control the terms of this debate; they put out the reports. Before embracing their position, here are a few observations that should give one pause:

First, the report concedes that “regulatory requirements, e.g., higher capital and leverage requirements, have reduced dealer ability and willingness to allocate capital to proprietary and market making activities, hold positions (particularly large inventories) in corporate bonds over time, and actively trade corporate bonds.” Given these changes in market regulation, it would actually be rather weird if liquidity had not declined. In fact, for it to keep steady, there would have to be some material liquidity-boosting developments in the market, but IOSCO does not report any.

Second, the regulators describe market participants’ perception as not being based on any reliable evidence. What the regulators really mean when they say this is that market participants are making a judgment based on their perceptions (rather than on having done studies independently) because as the regulators themselves concede, the evidence really does exist; it is just mixed.

Third, that the regulators and market participants are drawing opposite conclusions based on “mixed evidence” could indicate that different factors are being viewed as important. The regulators are asserting, for example, that the “bid/ask” spread is an important measure of liquidity. Conversely, market participants are saying that the bid/ask spread is less important than the size of the trade to which the spread relates. If the size of the trade is very small, the fact that the bid/ask spread is narrow is of much less relevance to them. So who is right as to which evidentiary measure is important? Here is one view: the persons who are the best judges of a product (which for this purpose includes a “market”) are those who actually use it; i.e., the market participants.

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